When the Internal Revenue Service calls a retirement account “tax-deferred,” it means you eventually have to pay taxes on the money. If you have a traditional individual retirement account, the taxes are due when you withdraw the money. The rules are different if you are making a qualified distribution from a Roth IRA. To make sure you pay those taxes at some point, the IRS requires that you gradually withdraw all of the money from the account.
Required Minimum Distribution
You can take money out of an IRA without penalty as soon as you are 59 1/2. If it’s a traditional IRA, you must start withdrawing a required minimum amount each year starting the year you reach age 70 1/2. Required minimum distributions are also mandatory for Simplified Employee Pension IRAs and Savings Incentive Match Plan for Employee IRAs. You do not have to take any money out of a Roth IRA. Once a Roth account is five years old and you are 59 1/2, Roth withdrawals are not taxable, so there is no reason for the IRS to require distributions.
Figuring Required Minimum Distribution
The IRS says to figure your annual required minimum distribution based on the balance in the IRA as of Dec. 31 of the previous year. Suppose your remaining life expectancy based on an actuarial life table (see Resources) is 10 years and the balance in your IRA is $100,000 as of Dec. 31, 2012. Your required minimum distribution for 2013 is one-tenth of the balance, or $10,000. The following year, IRS tables say your remaining life expectancy is nine years. Your required minimum distribution for 2014 will be one-ninth of the balance as of Dec. 31, 2013.
When you inherit an IRA from someone else, the required minimum distribution rules depend on your relationship with the deceased. If you are the surviving spouse, you can treat the IRA as your own. If you do, the required minimum distributions must begin when you reach age 70 1/2. If you choose to remain a beneficiary of the IRA, required minimum distributions start when the deceased would have been 70 1/2. If you inherit an IRA from anyone other than a spouse, you have two options. You can take required minimum distributions starting with the year after you inherit the IRA, using your own life expectancy to calculate the amount. Alternatively, you can withdraw all of the money within five years. If you choose the five-year option, there’s no annual requirement. You just have to empty the account by the end of the fifth year.
Failure to Make RMDs
If you do not take out all of a required minimum distribution by the end of the year, the IRS adds a 50 percent excise tax on top of ordinary income taxes due. Suppose you are supposed to withdraw $10,000 and you are in the 25 percent income tax bracket. If you don’t take the money out, you’ll pay $2,500 in ordinary income tax plus $5,000 as a penalty, leaving you with just $2,500.
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