When it comes time to withdraw money from a retirement plan, you should consider both nontax as well as tax considerations. Here are several of the nontax factors:
- Your need for the money
- Your life expectancy
- Your health
- Your future plans
The two main tax factors are:
- The penalties on withdrawing money from the retirement plan
- The tax a client pays on withdrawing the money
There are many penalties that apply to both distributions and the failure to make distributions from retirement plans. The rules for avoiding the 50% penalty are:
- Not too little
- Not too late
Not too Little
Once the age of 701/2 is reached, begin taking distributions from retirement plans and non-Roth IRAs. The minimum distribution one must receive annually is the amount that will distribute the entire balance in accounts over the distribution period. A 50% excise tax applies to distributions less than this amount. This 50% excise tax does not apply to distributions from retirement plans other than IRAs if one continues working after age 701/2 and one owns less than 5% of the company.
Calculate the minimum distribution by dividing the account balance on December 31st of the prior year (or the plan year-end in the case of a retirement plan) by the distribution period. Determine the distribution period using one’s age as of December 31st of the current year. The following table shows the distribution period. There are special rules if the spouse who is the beneficiary is more than 10 years younger than the retirement plan owner.
Minimum Distribution Periods
Table for determining distribution period. Final Regulations 1.401(a)(9) issued in April 2002. Effective beginning January 1, 2003.
Distribution Distribution Distribution Distribution
Age Period Age Period Age Period Age Period
70 27.4 82 17.1 94 9.1 106 4.2
71 26.5 83 16.3 95 8.6 107 3.9
72 25.6 84 15.5 96 8.1 108 3.7
73 24.7 85 14.8 97 7.6 109 3.4
74 23.8 86 14.1 98 7.1 110 3.1
75 22.9 87 13.4 99 6.7 111 2.9
76 22.0 88 12.7 100 6.3 112 2.6
77 21.2 89 12.0 101 5.9 113 2.4
78 20.3 90 11.4 102 5.5 114 2.1
79 19.5 91 10.8 104 5.2 115+ 1.9
80 18.7 92 10.2 104 4.9
81 17.9 93 9.6 105 4.5
For example:
A traditional IRA had a $50,000 balance on December 31st of last year. This year this person will be age 71. Their spouse will be age 68. The minimum distribution is:
Account balance $50,000
Divided by
Life expectancy ÷ 26.5
Minimum distribution $ 1,887
As a result of the regarding distributions from your retirement plans, you may wish to consider the following ideas:
- Reviewing the beneficiary designation form for the IRAs and retirement plans and naming contingent beneficiaries may be beneficial. The rules look to the beneficiary or beneficiaries as of September 30 of the year following the year the owner dies. However, the beneficiary must be named as either a beneficiary or contingent beneficiary while the owner is still living.
- Withdrawing the first required distribution in the year the owner turns age 701/2, rather than waiting until April 1 of the year following the year the owner turns age 701/2. This helps avoid bunching two distributions in one year and allows for a smaller required distribution in the second year.
Not Too Late
The owner must begin receiving distributions from the qualified plans and non-Roth IRAs no later than April 1st of the year following the calendar year in which the owner reaches age 701/2 (the required beginning date). A 50% excise tax applies to distributions received too late. An exception to this 50% tax applies to distributions from retirement plans other than IRAs if the owner continues working after age 701/2 and they own less than 5% of the company.
The April 1st date is relevant only in the year following the year the owner reaches age 701/2. After that, the owner must receive annual distributions by December 31st. Many people make the mistake of bunching two distributions in the year after reaching age 701/2 — one on April 1st and the second on December 31st. As a result, they pay tax at a higher rate and subject more of their Social Security benefits to tax than if they had received only one payment. However, if the tax rate is lower now than it will be in the future, it may be good planning to bunch two payments into one year.
However, if the owner waits until 2012 to take their first required distribution, they will have two distributions in 2012 since they must also take their next required distribution by December 31, 2012.
Distributions After You Die
If an owner’s retirement plan or IRA has money in it when they die, this money is distributed to the beneficiary or beneficiaries named for the retirement account. The beneficiary or beneficiaries as of September 30 of the year following the year the deceased passes may use the life expectancy tables to calculate the minimum amount to withdraw. A beneficiary must be designated as either a beneficiary or contingent beneficiary while the owner is still living. However, if there is no beneficiary designated for the retirement account, generally the plan must distribute the money by December 31st of the fifth year following the death.
If a spouse is the beneficiary, the spouse may roll over the plan balance into an account in his or her name as owners. Thus, the new account will be your spouse’s account.
Reporting
For information on how to report these penalties, see Federal Form 5329.
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