This week, Gail clarifies the Internal Revenue Service's requirement that you start taking a minimum amount of money out of your traditional IRA account after you reach age 70 1/2.
I've been reading your column for some time and it seems to me you consistently tell people to just withdraw the minimum amount required from their IRAs when they reach age 70 1/2. But aren't there cases when taking out MORE than that would be appropriate?
Most definitely: For instance, if you need the money!
IRS regulations require that the owner of a traditional IRA (but not a Roth IRA), start taking a minimum amount of money out of this account no later than April 1 of the year AFTER the year they reach age 70 1/2. However, you don't get to decide what this "minimum" is. There is a simple formula which tells you exactly the amount you need to withdraw. It's based on the value of your IRA and the combined life expectancy of you and your beneficiary.
Why must you take ANYTHING out of your IRA at all? Because the government wants the taxes you owe on your IRA money! Taxes which you have probably been able to postpone paying for decades. However, the IRS it isn't completely heartless. That's why it only requires you withdraw a minimum and not the entire amount.
Theoretically, just taking out the minimum over the joint life expectancy of you and your beneficiary means your IRA will last until the year in which you and your beneficiary are both deceased. In other words, in a perfect world, your IRA should be around to provide income to either you or your beneficiary through the last year of your -- or their -- life.
Let me illustrate how you calculate your required minimum withdrawal. Suppose your 70th birthday was in June of this year. This means you will officially be age 70 1/2 in December. Thus, the deadline for you to take your first required withdrawal is next April 1 (2004) -- the April 1 following the year you turn 70 1/2. This is merely the very LAST day to make your withdrawal; you can take your money out before then if you'd like.
To figure out the "minimum" amount you have to take each year, just use this formula:
IRA value on 12/31 of last year ÷ Life Expectancy
Turns out, according to the "Uniform Lifetime" Table provided by the IRS, the life expectancy for a 70-year old and her beneficiary is 27.4 years. This number assumes your beneficiary is no more than 10 years your junior. If your beneficiary is more than 10 years younger, this does not affect your life expectancy number.
We have reproduced the "Uniform Lifetime" table at the end of this column. It lists the life expectancy, or, in IRS-parlance, the "Distribution Period" for IRA owners as old as 115. The information can also be found on page 101 of IRS "Publication 590." (You can access this at http://www.irs.gov.)
There is one situation where you would NOT use this table -- and that is when the sole beneficiary of your IRA is your spouse AND he/she is more than 10 years younger than you. In that case, you would use a different life expectancy schedule called the "Joint and Survivor Life Expectancy" table. It, too, is found in Publication 590. However, the vast majority of people will use the life expectancies provided in the table found at the end of this article.
Let's assume your spouse is your beneficiary and he is 3 years older than you are. When you dig out your year-end statement from your IRA custodian (you did save it, didn't you?), you discover that on 12/31/02 your IRA balance was $136,694. Dividing this by 27.4 gives you $4,988.83. This is the "minimum" amount you have to take out of your IRA for your 70th year. You can make the withdrawal any time during 2003 and up until April 1, 2004.
After the first year, your minimum withdrawal must be made by December 31 of that year. But you figure the required amount the same way. For instance, assume that thanks to the recovery in the stock market, your IRA ends up being worth $148,962 on December 31, 2003.
Your withdrawal for 2004 -- the year you turn 71-- will be $5,621.21. You arrive at this by dividing your IRA year-end balance by the life expectancy for a 71-year old (26.5).
The following year you will divide your year-end IRA balance by 25.6 and so forth to calculate the smallest withdrawal you are required to make. And so on.
However, you are always free to withdraw more than the minimum.
Perhaps you want to take a special vacation, need money to make repairs on your home, have significant medical bills to pay, or simply want money for any reason at all. Or, maybe you want to spend down your assets to reduce your estate taxes. No problem. Provided you take out at least the minimum amount, there's no penalty. Keep in mind that you will owe income tax on the amount you withdraw, so the bigger your withdrawal, the bigger your tax bill.
Just don't take out LESS than the minimum. That's when it can get expensive. The IRS is not very forgiving in this area. The penalty for NOT taking a required minimum withdrawal is one of the harshest in the tax code: 50%! (If you withdraw some money, but not enough to meet the minimum required, you'll pay a 50% penalty on the amount of the shortfall.)
Going back to the above example, assume you didn't know you had to withdraw $4,988.83 from your IRA by next April 1st and the deadline passed you by. In that case, you can simply write the IRS a check for $2,494.42- half the minimum amount. OUCH!
Longtime readers of this column know that -- all things being equal -- an investment which has the potential to grow on a tax-sheltered basis will grow faster than the same investment in an account that does not offer this benefit. In addition, I'm a big believer in not paying taxes unless you absolutely have to. For both of these reasons, it makes sense to leave as much money as possible in your tax-deferred IRA. But if you need the money, by all means, withdraw more than the minimum required.
Hope this helps!
P.S. Keep in mind that the OWNER of a Roth IRA never has to take required withdrawals, no matter what his/her age. But some one who inherits a Roth IRA MUST take required distributions -- no matter what their age -- beginning by December 31st of the year AFTER the Roth IRA owner died. (Yes, I know that in a Roth IRA withdrawals are income tax-free. But you've still got to take them! Don't ask me to justify the tax code.)
Again, there is a special option for a SPOUSE who is the beneficiary of a Roth IRA: He can ROLL OVER the Roth IRA into his own name. Then, as the new "owner" of the Roth, he is not required to take any withdrawals.
UNIFORM LIFETIME TABLE
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