The IRA Blunder You Must Avoid

After a lifetime of saving money in their retirement accounts, many retirees are reluctant to start taking money out of them. But if you're in your 70s or older, you probably have to start taking IRA and 401(k) distributions right now -- or face stiff penalties from the IRS.

Retirement accounts have great tax benefits, letting you defer taxes on the income from your investments until you make withdrawals. When it wrote the laws creating these accounts, Congress understood that many taxpayers would try to delay paying taxes on their money as long as they possibly could.

Because the whole purpose of these accounts is to save for retirement expenses, the tax law includes provisions that require retired IRA and 401(k) owners above a certain age to make at least some withdrawals each year. The required minimum distribution (RMD) rules define exactly what you have to do.

Who has to take withdrawals?
The magic age at which you have to start taking money out of your retirement accounts is 70 1/2. That means that if you were born earlier than July 1, 1937, you'll have to withdraw a certain amount from IRA and 401(k) accounts. There's an exception, however, if you're still working -- but only for the 401(k) plan offered by your current employer. You still have to take money from your IRA accounts and from 401(k) plans from former employers.

Most people who are subject to the RMD rules have to make their withdrawals by Dec. 31 each year. However, if you just turned age 70 1/2 this year, you get a one-time extension to get it done by April 1, 2008.

Seniors aren't the only people who have to take withdrawals from retirement accounts. If you've inherited an IRA or 401(k), then you have to meet the RMD rules regardless of how old you are.

How much do you have to take?
The minimum amount you have to take out of your retirement accounts also depends on your age. In simple terms, you must withdraw a fraction that's based on your life expectancy. So if you have a life expectancy of 10 years, then you have to take out one-tenth of your account balance as of the beginning of the year.

The IRS publishes tables that tell you what your life expectancy is. In general, those in their 70s will have to take around 4%-5% of their account balance each year, increasing to 5%-8% in their 80s and 8%-16% in their 90s. However, there's a special table to use if you're married to someone who's more than 10 years younger than you are. You can find these tables and more information from IRS Publication 590.

If that's too confusing, however, your broker may help out. Brokers like Charles Schwab (Nasdaq: SCHW  ) and TD Ameritrade (Nasdaq: AMTD  ) will help you calculate your required minimum distribution on request. Mutual fund companies such as T. Rowe Price (Nasdaq: TROW  ) also have forms to request your RMD amount, while others, including Janus Capital (NYSE: JNS  ) , give you calculators to help you figure it out yourself.

What if I don't take my money?
You definitely don't want to forget to take your required minimum distribution. The IRS imposes a penalty of 50% of whatever you should have taken out. From the figures above, you can see that the penalty can amount to 2% or more of your entire retirement account.

No one wants to pay more taxes than they have to. Delaying taking money out of your retirement accounts can help you reduce taxes for a while. But when the time comes, make sure you withdraw at least what you have to in order to avoid a huge blunder.

See these articles to learn more about:

Help us in our goal to give every young person around the globe a financial education!  Learn more about the new direction of Foolanthropy, now in its second decade, here.


Read/Post Comments (0) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 557220, ~/Articles/ArticleHandler.aspx, 10/31/2014 11:52:14 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement