Taking Money Out of Your IRA
Because IRAs are designed for tax-advantaged retirement savings, there are times when you should not take money out, when you can take money out, and when you must take money out. These rules are intended to discourage people from tapping their retirement funds early, so they won't become destitute in their old age. The rules are also designed to put a finite life on the tax deferral so that the IRS will eventually be able to collect. In some ways the mandatory distribution rules -- called required minimum distributions or RMDs -- are more stringent than the premature distribution rules. The penalty for taking money out before reaching age 59-1/2 is just 10% -- and there are several ways to get around that. But the penalty for taking out less than your required minimum distribution after age 70-1/2 is 50%! Uncle Sam is only so patient. Eventually you will have to pay up, and ignorance of the rules is no excuse.
Here are the general rules for taking distributions from a traditional IRA:
We are trying to make IRA distributions seem simple and easy to understand, but they can be very complex due to the many rules and exceptions. Individuals with large IRAs and complicated tax and estate planning issues should get qualified advice to avoid paying unnecessary taxes and penalties. Advice should especially relate to:
Select a tab below to learn more about taking money out of your IRA.
Cracking the nest egg early: avoiding penalties on premature distributions
The IRA distribution rules recognize that some people may want to retire before they turn 59-1/2. To penalize them doesn't seem fair when all they want is to draw their own monies back as reportable income during retirement -- this, after all, is the purpose of an IRA. So, individuals who would like to tap their IRA early are allowed do so without penalty, as long as they set up a program for substantially equal periodic payments that lasts five years or until they turn 59-1/2, whichever period is longer. These are called Section 72(t) withdrawals and they must be set up properly or penalties may apply. Your financial advisor or IRA custodian should be able to help you with this.
Some years ago Congress realized that people sometimes need access to their retirement funds early for certain worthwhile expenditures such as first homes, higher education, and health care. So a provision was made for allowing penalty-free distributions prior to age 59-1/2 for these and certain other reasons. As you might expect, there are lots of rules. If you are interested in taking penalty-free withdrawals for any of the following reasons, be sure to look into the details associated with them:
When you turn 70-1/2: Understanding required minimum distributions
IRA distributions must begin when you turn 70-1/2. Technically, the first required minimum distribution (RMD) must be taken no later than your required beginning date (RBD), which is April 1 of the year after turning 70-1/2. However, it is usually advisable to take your first RMD by December 31 in the year you turn 70-1/2 to avoid taking two taxable distributions in one year.
The calculation of RMDs is relatively simple. Just take your IRA balance on December 31 of the previous year and divide by your life expectancy as indicated in the IRS Uniform Lifetime Table. See Appendix C of IRS Publication 590. Use Table III unless your beneficiary is your spouse who is more than 10 years younger than you, in which case you would use Table II. For example, let's say that you'll be turning 70-1/2 this year and that at the end of last year your IRA was worth $500,000. According to the IRS table, a 70-year-old individual has a life expectancy of 27.4 years. So you would divide $500,000 by 27.4 and get $18,248. This is the amount you must take out by December 31 (or April 1 of next year if you want to take advantage of the grace period). Next year you would do it again: take the account balance at the end of this year and divide it by the life expectancy for a 71-year-old, which is 26.5. This is the amount you must take out by December 31 of next year.
You will notice that your life expectancy does not decrease by one full year as you get one year older. This is because the longer you live, the longer you are expected to live. So if you make it to the ripe old age of 105, the table says you still have 4.5 years to go. This works in your favor by not forcing you to deplete the account before the end of your life.
Be aware that RMDs are minimums. You can always take out more than the minimum but of course you would owe income tax on the total amount.
Special rules for inherited IRAs
If you are the beneficiary of an IRA, you must be mindful of the rules that must be followed after the IRA holder dies. These can be complicated, so watch out. If you are the spouse of the IRA holder you will follow one set of rules. If you are a non-spouse beneficiary, you will follow a different set of rules. The main thing to be aware of is that you may have to start taking RMDs the year after the year the IRA holder dies, and the penalty for under-withdrawals is 50% of the amount that should have been withdrawn.
The 60-day rollover option is not available to non-spouse beneficiaries. If you have inherited an IRA from someone other than your spouse and want to move it to a different custodian, you must arrange a direct trustee-to-trustee transfer. If you somehow mess up and have the custodian issue you a check, it will be considered a taxable distribution (but no penalties will be due). Also be aware that inherited IRAs must be titled properly to preserve the tax deferral.
Your financial advisor or IRA custodian should be able to help you navigate the rules for inherited IRAs. Get a second opinion if you do not feel confident in the advice you are receiving.