Advance planning can, in many cases, minimize or even avoid taxes on IRA distributions and other qualified plan distributions. When contemplating future retirement and when to begin tapping taxable IRA and other qualified retirement accounts, taxpayers need to consider a number of important issues.
Early Distributions (before 59 ½)
If funds are withdrawn before reaching age 59 ½, the taxpayer is subject to a 10% early withdrawal penalty (and state penalties if applicable) in addition to the income tax on the IRA distribution, unless what is referred to as the substantially equal payment exemption is utilized. Under this exception, an early retiree can begin taking substantially equal payments at least once a year over the owner’s life or joint lives of the owner and designated beneficiary. The payments must not cease before the end of the five-year period beginning with the date of the first payment, BUT after the taxpayer reaches age 59 ½.
Age 59 ½ to age 70 ½ Distributions
After attaining age 59 ½, an individual can take out of their IRA as much or as little as he or she wishes in any year until reaching age 70 ½. This withdrawal liberty leaves the retiree to plan his or her distributions to minimize taxes. Techniques involve matching distributions with no- or low-income years.
Age 70 ½ and Older
Once a taxpayer reaches age 70 ½, he or she must withdraw at least a minimum amount from their Traditional IRA each year. A taxpayer who fails to take a distribution in the year age 70 ½ is reached, can avoid a penalty by taking that distribution no later than April 1st of the following year. However, that means the IRA owner must take two distributions in the following year, one for the year in which they reached age 70 ½ and one for the current year. Distributions that are less than the required minimum distribution for the year are subject to a 50% excise tax (excess accumulation penalty) for that year on the amount not distributed as required. The excess accumulation penalty can generally be abated by following IRS abatement procedures.
Quite frequently, taxpayers have multiple IRA accounts in addition to one or more types of other retirement plans. This gives rise to a commonly asked question, “Must I take a distribution from each individual account?” For purposes of the annual required minimum distribution, a separate distribution must be taken from each type of plan. However, a taxpayer may have multiple accounts for each type of plan, which for tax purposes are treated as one plan. For example, if you have three IRA accounts, the three separate accounts are treated as one for tax purposes, and the distribution can be taken from any combination of the accounts.
Generally, the minimum amount that must be withdrawn in a particular year, after reaching age 70 ½, is the total value of all IRA accounts (as determined on December 31st of the prior year) divided by a factor based on the owner’s age from the table below, illustrated for ages 70 – 87 only (the complete table goes to age 115 and older).
Minimum Distribution Table
|
Age
|
Factor
|
Age
|
Factor
|
|
70
|
27.4
|
79
|
19.5
|
|
71
|
26.5
|
80
|
18.7
|
|
72
|
25.6
|
81
|
17.9
|
|
73
|
24.7
|
82
|
17.1
|
|
74
|
23.8
|
83
|
16.3
|
|
75
|
22.9
|
84
|
15.5
|
|
76
|
22.0
|
85
|
14.8
|
|
77
|
21.2
|
86
|
14.1
|
|
78
|
20.3
|
87
|
13.4
|
Estate and Beneficiary Considerations
When planning your distributions, keep in mind that the value of your undistributed IRA account will be included in your gross estate when you pass on, and depending upon the size of your estate, it may be subject to inheritance taxes. In addition, the inherited IRA distributions will be taxable to the individual who inherits the IRA. Therefore, it could be appropriate to utilize the IRA funds first and then dip into other assets after the IRA funds have been depleted. On the other hand, funds left in an IRA do continue to accumulate tax-free, which might be better in certain circumstances.
If you would like assistance with your tax planning needs or to develop an IRA distribution plan, contact the experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
