Managing Your Retirement

70 1/2: Ya Gotta Take It Sometime

Managing Your Retirement

We've looked at how you may take qualified retirement plan or traditional IRA tax-deferred money before age 59 1/2 without penalty. You can do it -- but it's complicated.

Between the ages of 59 1/2 and 70 1/2 (the so-called "easy math" years of your retirement), you may take as much or as little as you wish from your tax-deferred accounts. You'll pay taxes on the withdrawals (unless it's a Roth IRA), but no penalties are involved.

Reach age 70 1/2 (there's that important half year again), and our administrative friends in Washington say the free ride of tax-deferred accumulation is OVER. No more hoarding -- the government has been exceedingly patient, but there are limits. It wants you (actually it needs you) to start paying some taxes, so you've got to start taking the money out of that IRA. You must take a "minimum required distribution" (MRD).

What Happens When You Turn 70 1/2

At 70 1/2, previously untaxed money amassed in retirement plans and traditional IRAs will start to be taxed. Only money in a Roth IRA can continue to avoid taxation. If you're still working, then anything in your qualified retirement plan at that job can stay there until you retire. But if you're retired, any money in that plan must come out. And regardless of your work status, at 70 1/2 you must take an MRD from your traditional IRAs.

The Internal Revenue Code requires that MRDs begin no later than April 1 of the year following the year you reach age 70 1/2. Remember that much. The next few sentences will be put in brackets to emphasize that they aren't the main point -- they're kind of the footnote to what was just said.

[If you turn 70 1/2 on January 1, 1999 -- or any day in 1999 -- that means you must begin your MRD no later than April 1, 2000. While the first MRD will be for tax year 1999, actually taking it in 2000 means you won't report that withdrawal income until you file your income tax return for 2000. BUT (warning -- the inevitable catch is coming) your second annual minimum withdrawal must be for and occur in the year 2000 as well. That means you must make the second distribution no later than December 31, 2000, which results in another taxable IRA event in that year. As usual and as always, you'll have to look at your tax situation to see if you want those payments lumped into the same tax year.]

Whatever you decide, make sure you take the MRD by the deadlines prescribed. If you fail to do so, the IRS will be very happy. Why? Because it will assess a penalty of 50%(!!!) on the monies you should have taken but did not. Fools are good citizens. Doggone it, Fools are great citizens -- and comply with their civic duties willingly. We're sure you do, too, dear Fool. But paying a 50% penalty seems to be carrying the concept of good citizenship toward the socialist side of the spectrum a tad too far. Therefore, Fools will avoid paying that penalty at all costs.

You may take more than the MRD, but you must take at least that amount or pay the 50% penalty on anything you should have withdrawn. Any excess you take above the MRD, though, does not count toward the next year's MRD.

How MRDs Are Calculated

Under old IRS regulations, the MRD is calculated using a life expectancy factor that's based on your age, the age of your IRA or plan beneficiary, and the total balance of your IRA or retirement plan as of December 31 of the previous year. The procedures for finding that factor and for calculating the amount of the MRD are prescribed in IRS Publication 590, Individual Retirement Arrangements.

Under newly proposed regulations, as of January 1, 2001, those taking MRDs from IRAs may opt to use a new uniform life expectancy table that assumes the IRA or plan owner has a beneficiary who is exactly ten years younger than the account owner. Each year the account owner would find a life expectancy factor in that table that corresponds to the attained age of the owner in that year. That factor would then be divided into the account balance as of December 31 of the prior year to determine the new year's MRD. For most people, use of the new regulations will result in an extended tax-deferred life for and lower taxes on the account. Use of the new methodology is optional in 2001, but is anticipated to become mandatory in 2002 for those who must begin MRD in that year.

When You Have Multiple IRAs

Currently, you are responsible for computing the MRD for each of your IRA. Under the new rules, starting in 2002 each IRA custodian will compute the MRD for that IRA. The MRD amount will be reported to you and the IRS. Whether you compute the MRD this year or your IRA custodian does next year, when you own multiple IRA you have a choice of which IRA you use to meet the total amount of MRDs you must take. Just total all the MRDs computed for each IRA. That total may then be taken from any one or any combination of IRAs. This proviso may be useful if you have one IRA earning a 6% return and another earning 18%. The Foolish choice would be to deplete the lower-returning IRA first, and to allow the better one to continue its tax-deferred compounding.

The issue of MRDs and the selection of beneficiaries has a great bearing on the taxation of estates and the net proceeds that will be available to heirs at death. Therefore, make sure you've given plenty of thought to how to Leave It Behind.

Continue »