Withdrawing from your Retirement Accounts

When you begin to tap into your retirement savings, conventional wisdom generally dictates to take your money out in two allocations. First, draw on funds outside of your Individual Retirement Account, company pension plan or any other tax-deferred investments, thereby sheltering as much money in them for as long as you possibly can. Only later should you draw on these sources. But tax law tinkering by the federal government has had the effect of complicating this simple approach.

Current IRS guidelines call for the commencement of mandatory taxable withdrawals at age 70½ from all tax-deferred accounts – even if you're still working. Included are IRAs and company plans such as pensions, profit-sharing accounts, 401(k)s and 403(b)s. (As an exception, however, most employees who turned 70½ before January 1, 1988 are allowed to wait until they actually retire to begin receiving distributions from a company plan.) The rules contain precise timetables for taking the payout and revised life expectancy tables for computing the amount. They also come with a substantial penalty for noncompliance; underwithdrawals may be punished by a tax equal to fifty percent of the distribution deficit. Listed below are a few tips and notions to keep in mind to help you manage your tax-favored accounts to your best advantage while at the same time keeping the IRS satisfied.

You must begin withdrawals for the year in which you turn 70½. If your 70th birthday falls after July 1, you're required to calculate a minimum withdrawal for the year. Generally, the deadline for taking your cash out is December 31st; however, you may postpone your first withdrawal until April 1st of the following year.

The amount of the minimum withdrawal is based on both your age and the total amount of funds in each tax-deferred account at the beginning of the year for which you're making the withdrawal. For example, let's assume that you turned 70½ and your IRA was worth $100,000 on January 1st. To calculate your minimum distribution, you'd need to divide the account balance by the number given for your age in the life expectancy tables, which are found in IRS Publication No. 590, Individual Retirement Arrangements (if you have a beneficiary, the appropriate table will also list his or her age to arrive at a single number representing your joint life expectancy).

For your first withdrawal, you would use age 71 for yourself and, say, 70 for your beneficiary, because the calculation is based on your ages at the end of the year for which the withdrawal is being made. Therefore, the amount of your first mandatory withdrawal must be at least $3,773.58 ($100,000 divided by 26.5, the life expectancy for a 71-year-old IRA owner with a spouse that's less than ten years younger – using the 2006 table). If you also have money in a company plan, your employer will compute the amount of the distribution. But it's your responsibility to make sure that the IRS minimum is met.

From another perspective, if the owner of a retirement account dies having done no additional planning other than designating beneficiaries of the account, the named beneficiaries will generally have only two options with regard to the account: either take whatever share of the account they've been given in a lump sum, or take only the required minimum distribution (RMD) each year.

The RMD is based on the life expectancy of the beneficiary, again according to an IRS actuarial table. The account balance is divided by the number of remaining years in the beneficiary's life to calculate the amount that must be distributed each year. A young beneficiary, for example, typically has many years of expected life. In such a case, the account balance would be divided by a rather high number, resulting in a relatively low payment requirement to be distributed from the account each year.

But why would any beneficiary want to take his distributions in the smallest annual installments allowed, rather than a single big one? Such a course of action might be chosen for a number of possible reasons. First, if the beneficiary were to take a big lump sum distribution in a single year, he or she would likely be thrown into a higher income tax bracket. Second, the beneficiary may want to delay the payment of income tax and let the account continue to grow tax-deferred. Most retirement account contributions are made with dollars that have yet to be subjected to income tax. No tax is paid as the account grows in value over the years, but ordinary income tax is payable on any funds that are withdrawn. That's also the main reason for the existence of the RMD – the law requires at least some portion of the account be distributed each year to ensure that it doesn't grow too much without the IRS getting its' share.

In theory, therefore, it makes good sense to maximize the tax-deferred growth of the funds by taking only the minimum required by law. Among attorneys and financial planners, this is certainly the most widely acknowledged estate-planning goal for retirement assets. Although there's no single best approach to retirement fund distribution planning, there is obvious value in letting the money grow for as long as possible. As an example, a retirement account owner could be quite fortunate tax-wise if he or she has a beneficiary with a long life expectancy (a child, for example) over which the required distributions can be stretched out. Money not withdrawn can continue to grow, perhaps for decades, adding to the financial security of the account owner's surviving family.

Distribution options and decisions should always be considered with the utmost diligence and care. Educate yourself thoroughly about plan provisions, and be sure to obtain solid and practical professional advice before taking the first step. The rules can be strict and confusing – not only in the law itself, but also among the various plan documents and IRAs in use around the country. The structure of a particular retirement plan document could prevent you from following a course of action that would otherwise be legally acceptable.

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