An individual retirement arrangement is a retirement savings vehicle with added tax benefits. There are two different types of IRAs, both offering tax advantages. Traditional IRAs provide you with bigger tax benefits now, while Roth IRAs allow you to reap the benefits when you retire. If you have a traditional IRA, you might decide to continue deferring taxes by keeping the funds in the account. However, if you do not begin taking distributions by the time you reach age 70 1/2, you will face substantial tax consequences.
A traditional IRA is one that is part of an employer-sponsored retirement plan. Your pretax earnings are used to fund the account. When you retire, your annual distributions are reported as income and taxed at ordinary tax rates. You cannot tap into the account without penalty until you reach age 59 1/2. Although you are not required to begin taking withdrawals when you hit 59 1/2, you are required to begin taking mandatory withdrawals at age 70 1/2.
Deadline to Begin Distributions
According to the IRS, you must begin taking required minimum distributions by April 1 of the year after you turn 70 1/2. For example, if you turn 70 1/2 in 2012, take your first minimum withdrawal no later than April 1 of 2013 to avoid penalty. After your first distribution, annual distributions are required by Dec. 31 of each year. If you delay taking your first distribution until the year after you turn 70 1/2, you are actually taking two distributions in the same tax year. If you do not take your required minimum distribution, a 50 percent tax is assessed on the distribution amount you failed to take.
Calculating the Minimum Distribution
The required minimum distribution is calculated for each account by dividing the prior Dec. 31 balance of the IRA by the life expectancy factor tables the IRS releases annually in Publication 590, Individual Retirement Arrangements. There are three different tables to use, depending on your account. The Joint and Last Survivor Table is for an account owner whose sole beneficiary a spouse; the spouse must be more than 10 years younger than the account owner. The Uniform Lifetime Table is used by account owners whose spouse is not the sole beneficiary, or if the spouse less than 10 years younger. The Single Life Expectancy Table is used for inherited IRAs. If you have more than one IRA, you must calculate the required minimum distribution for each account separately.
A Roth IRA is an account you fund with after-tax contributions. This type of account is not part of an employer-sponsored plan. You do not receive any tax breaks on your contributions for the year, but there are some benefits associated with a Roth IRA. Qualified earnings are not taxed. Your investment grows tax-free, rather than just tax-deferred. Since the IRS does not need to collect taxes on your contributions, there is no requirement to begin taking distributions at age 70 1/2. You can allow the funds to continue earning interest for as long as you desire. In addition, you are free to withdrawal your principal before reaching 59 1/2 years of age.