People use IRAs to save for retirement throughout their careers, and it's easy to find information on how to invest your IRA to make it grow. What's harder is getting good guidance about how to withdraw money from your IRA prudently. Depending on your age, there are different rules you can follow about taking IRA withdrawals, some of which are mandatory and others of which are up to you.
The magic ages of 59 1/2 and 70 1/2
For reasons now lost to legislative history, lawmakers set the age for taking penalty-free distributions from your IRA at 59 1/2. Once you reach this age, you're allowed to withdraw as much money as you want from your IRA without penalty. There's no monthly limit, but you have to keep in mind that traditional IRA distributions will always be subject to income tax. You might therefore prefer to take smaller amounts out spread over the course of your retirement years.
The IRS gives you that complete flexibility over your withdrawals until the year you turn 70 1/2. At that point, you must start taking distributions from your traditional IRAs. The exact amount depends on your age and your IRA balance at the end of the preceding year, with the calculation using IRS life-expectancy tables to come up with required annual distributions. For instance, if you turned 70 1/2 and had an IRA with a balance of $100,000, the IRS would calculate your life expectancy at 27.4 years. You'd therefore have to withdraw $100,000 divided by 27.4 or $3,650 at some point during the year, which works out to about $305 per month. As you get older, your life expectancy declines, and so the annual distribution requirements become larger if your IRA balance stays stable or grows over time.
Getting money before 59 1/2
If you want to make IRA withdrawals before age 59 1/2, you'll pay penalties unless you qualify for an exception. Withdrawals for special purposes, such as up to $10,000 toward a first-time home purchase or money spent on higher education expenses, avoid the 10% penalty on early withdrawals.
But there's also a catch-all that provides for what are known as substantially equal periodic payments. You can take these payments annually, semi-annually, quarterly, or monthly, and you can use any of three methods to figure out the appropriate amount. The simplest is the required minimum distribution method, which uses the same general methodology that those over age 70 1/2 use. More sophisticated methods include the amortization and annuitization methods. They require more complex inputs, including a set of interest rate assumptions, but they can produce larger permitted withdrawal amounts. For instance, for a 50-year-old with a $100,000 IRA, the RMD method using the single life table produced an annual amount of $2,924, or $244 per month. By contrast, the amortization and annuitization methods both produced figures closer to $4,100, or nearly $100 per month higher.
What should you withdraw?
Finally, beyond what you can withdraw from your IRA, you might also want to keep in mind how much it really makes sense take out. For instance, many retirees use the 4% rule to determine income needs in retirement, which essentially would have you figure out 4% of your total retirement assets and then withdraw that amount each year, adjusting it upward for inflation.
Prudent management of your IRA is vital for long-term financial security in retirement. These rules will give you a good starting point on how much you can afford to withdraw from your IRA.
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