Assume that you are retired, that you will be age 57 for the rest of this year, and that you have three IRAs that each had a balance of $125,000 on the last day of last year. You need to take money from your IRAs for income.
- May you take income from your IRAs free of penalty?
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- Must you take money from each of your IRAs?
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- If you begin taking SEPP from an IRA at age 57, may you discontinue doing so at age 59½?
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You have been taking SEPP under one of the three IRS-approved methods for three years, but decide you don't need as much money as that method allows. You decide to switch methods, and use a different one for the SEPP computation this year.
- May you switch SEPP methods?
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- If you change your SEPP withdrawal methodology, what happens?
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Assume you are older than age 59½, have never used SEPP for your traditional IRAs, and are not yet old enough for required distributions.
- How much may you take from your traditional IRAs?
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- When must you take money from your traditional IRAs?
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- What happens when only $400 of a $500 MRD is taken in a particular year?
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Assume that at your age 60 retirement you have 1000 shares of company stock in a qualified Employee Stock Ownership Plan that you may take with you at retirement. The stock has a basis (or cost) to you of $10,000 and is now worth $100,000.
- If you take the shares instead of transfering them to an IRA, on what amount will you pay income taxes?
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- If you transfer those shares to a traditional IRA and sell them to take a distribution of cash from that IRA, will you be able to use long-term capital gains tax rates in computing the taxes due on your distribution?
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Don't fret! We'll admit this isn't the easiest stuff, but it's important, so if you have any questions head over to the Retirement Realities board.
Answers
1. May you take income from your IRAs free of penalty?
Answer: Yes, provided the withdrawal is computed using one of the three IRS-approved methods for taking distributions as part of a series of "substantially equal periodic payments" (SEPP).
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2. Must you take money from each of your IRAs?
Answer: No. Each IRA stands alone for SEPP purposes. It's possible to begin SEPP under one method using one IRA, discover the income is insufficient two years later, and then begin SEPP in a second IRA in that year using an entirely different IRS-approved withdrawal method.
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3. If you begin taking SEPP from an IRA at age 57, may you discontinue doing so at age 59½?
Answer: No. You must take SEPP for at least five years or until you reach age 59½, whichever period is longer. In this case, you must use five years, or until you reach age 62..
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4. May you switch SEPP methods?
Answer: No. You must use the same method for all SEPP withdrawals from the same IRA.
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5. If you change your SEPP withdrawal methodology, what happens?
Answer: The IRS will disallow all prior withdrawals. You will be assessed a 10% early withdrawal penalty on the total amount taken over the years. You will also be assessed an interest charge for failing to pay the penalty in the year each withdrawal took place.
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6. How much may you take from your traditional IRAs?
Answer: As much or as little as you wish. Between the ages of 59½ and 70½ there is no minimum or maximum distribution required from a traditional IRA.
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7. When must you take money from your traditional IRAs?
Answer: You must begin minimum required distributions (MRD) by the "required beginning date (RBD)," which is no later than April 1 of the year following the year you attain age 70½.
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8. What happens when only $400 of a $500 MRD is taken in a particular year?
Answer: You will be penalized 50% of the amount that should have been taken, but was not. If you were required to take $500, but only took $400, then you failed to take $100 of the required amount. You would pay a $50 penalty on the $100 that did not get distributed. Remember that you may always take more than the MRD, but you cannot take less without paying a penalty.
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9. If you take the shares instead of transfering them to an IRA, on what amount will you pay income taxes?
Answer: You will pay ordinary income taxes on your basis of $10,000. The remaining $90,000 in value will be taxed at long-term capital gains rates when you later sell those shares regardless of how long you have held them before the sale. (See Taking Stock)
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10. If you transfer those shares to a traditional IRA and sell them to take a distribution of cash from that IRA, will you be able to use long-term capital gains tax rates in computing the taxes due on your distribution?
Answer: No, you will be taxed at ordinary rates on the entire distribution taken from the traditional IRA. Capital gain or loss income taxation rates do not apply to distributions taken from IRAs. (See Taking Stock)
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