The tax man giveth and the tax man taketh away. IRAs provide great tax incentives for individuals to save for retirement. These accounts allow individuals to take an income tax deduction for the money put into an IRA, up to certain limits, and the money can be invested and grow tax deferred until the money is withdrawn in retirement. While we have been given this great tax incentive and opportunity to assist in saving for retirement, the IRS is going to want its money eventually. So when money is withdrawn from the account, the amount withdrawn each year will be taxed as income to the IRA owner. Further, the IRS wants to make sure that its gets the tax money when it is owed, so individuals are required to begin taking mandatory withdrawals from the account beginning at age 70½.
Required Minimum Distributions - When to Start
The first Required Minimum Distribution (RMD) from an IRA must be taken by April 1 of year after the account owner turns age 70½. For each subsequent year, the deadline to take the RMD payment is December 31st. The amount that must be withdrawn is based on a life expectancy table set forth by the IRS, and any required amount not withdrawn by the deadline will be assessed a 50% penalty on the required distribution amount.
Calculating the RMD
To determine the required minimum distribution amount each year, the account value on December 31st of the previous year is divided by the age factor from the life expectancy table. At age 75, for example, the distribution factor is 16.3. The factor of 16.3 in this case is based on actuarial assumptions that the average 75 year-old will live another 16.3 years. So for a 75 year old with a $100,000 IRA, he would divide $100,000 by the factor of 16.3 for a required minimum distribution of $6,314.96. If the individual does not take any of this amount by the deadline, he will be assessed a penalty equal to one-half of the RMD, or $3,157.28. It is imperative that IRA owners understand the importance of taking the RMD by the deadline to avoid this punitive tax penalty.
Distributions From Multiple IRAs
It is also important for IRA owners to ensure they include all IRA accounts in calculation of required distributions. If you have more than one IRA with multiple financial institutions, it is necessary to ensure the minimum distribution is calculated on the value of all IRA accounts owned. Luckily, most financial institutions will provide IRA account holders with the required minimum distribution amount each year. Further, the distribution can be taken from one of the IRA accounts, or it can be spread out across all accounts owned. As long as the total RMD amount for all accounts is taken out of at least one of the IRAs, the RMD will be satisfied.
As difficult as it to plan for retirement and set aside retirement funds for future use, the rules surrounding IRAs as we reach age 70 and beyond tend to make things even more difficult. IRAs are a great way to save for retirement, particularly with the tax incentives they provide. But as you reach age 70, remember the rules, and remember that the IRS wants reimbursement for the deferred taxes in your IRA.