The rules concerning individual retirement accounts do not allow you to let the money grow tax-deferred forever. When you reach age 70 1/2, the clock begins for you to start taking annual required minimum distributions, commonly called RMDs. The timing for the first RMD gives you some extra time, while the required withdrawals for the following years must be taken annually.
IRA Tax Deferral
It is probable that all or most of the contributions you made into your IRA were before tax, and the growth or earnings on the account were tax-deferred. This means that withdrawals from your IRA will be taxable income to be included on your tax return for the year. As long as you do not make withdrawals, you pay no taxes on your IRA. The required minimum distribution rules force you to start making annual withdrawals when you reach the age of 70 1/2 and to pay taxes on those withdrawals.
Your first RMD is due for the year in which you turn age 70 1/2, but you do not have to make the RMD withdrawal during that year. You have until April 1 of the following year to take the first RMD. In subsequent years, the RMD withdrawal from your IRA must be taken by Dec. 31. If you like waiting until the last day, you will end up taking two RMD withdrawals during the year after the year you turn 70 1/2 -- one by April 1 and the second by Dec. 31.
The RMD for each year is calculated by dividing the IRA value at the end of the previous year by your life expectancy in years from a table published by the Internal Revenue Service. The life expectancy tables can be found in the IRS Publication 550. Most IRA owners use the life expectancy from the Uniform Lifetime Table. If you are married and your spouse is more than 10 years younger, use the life expectancy from the Joint and Last Survivor table.
Failure to Comply Penalties
If you do not take a RMD by the required date, the IRS will charge a 50-percent tax on the amount that should have been taken from your IRA. You still must make the withdrawal and pay the extra tax. After age 70 1/2 you must withdraw at least the calculated RMD for each year. You can make a larger withdrawal, but any extra does not count towards future RMDs.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.