TRAVERSE CITY — As the year draws to a close, I’m often asked by those who have reached age 70 about their need to start taking money out of their individual retirement accounts (IRAs). Here’s a quick lesson on the current retirement account distribution rules.
The minimum amount you must withdraw annually from your IRA is based on your life expectancy. Every year you have to withdraw an ever larger percentage of your retirement accounts. The required minimum percentage is figured using your IRA account balances from the end of the previous year. Basically, the older you get the more the IRS plans to squeeze out of your IRA accounts and the more that spills onto your tax return.
Think of the IRS as a troll that guards the crossing that separates your retirement accounts funded with pre-tax money from your regular accounts. The rules force retirees to annually lug a bag of money over that crossing and the IRS collects its toll.
Technically, you have to begin taking what’s known as a “required minimum distribution” from your IRA accounts by April 1 of the calendar year following the year you hit age 70 ½. However, most people decide to take their first distribution in the same calendar year they actually reach age 70 ½. Why? If you choose to wait until the deadline, you also have to take your next withdrawal by the end of that same calendar year. This doubling up of distributions in one tax year could push you into a higher tax bracket and result in a bigger tax bite.
Also, it is very important for you to consider all of your retirement accounts when figuring your distribution amount. While you are allowed to meet your required distribution by drawing from just one of your IRAs, you must satisfy the minimum amount based on the total value of all of your IRAs. If you accidentally forget an account, you’ll face penalties of 50 percent of your minimum distribution shortfall. That’s a pound of flesh for what seems like an innocent mistake!
Lastly, you might be interested in some possible side effects on your tax return as a result of your required minimum distributions. If you itemize on your federal tax return, your IRA distributions will effectively weaken the tax benefits of your itemized expenses by raising the thresholds for their tax deductibility. This is precisely why making charitable donations directly from your IRA is such a popular maneuver.
Reaching age 70 ½ is a milestone that shouldn’t result in a lot of extra work for you. One simple step you can take to make things easier is to consolidate what might be multiple IRAs into just one account. This helps combat what is a needlessly complex set of considerations for retirees.
It seems only Congress could design a system such as this. Just think, about a decade ago these rules were actually adopted in the name of legislative reform.
Jason P. Tank is a chartered financial analyst and co-owner of Front Street Wealth Management, a fee-only wealth advisory firm in Traverse City. He encourages questions and comments about future columns. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com