Q: I keep hearing about taking minimum annual withdrawals
from your IRA after you turn 70 and a half years old. But I'm not sure how it works. If I have $400,000 in my
IRA when I'm 70 and a half, and I take out interest every month to live on,
does that qualify as part of the minimum annual distribution requirement? I
hope so! -- JP
A: Not to worry. Of course it does.
The law requires you to start taking minimum
annual distributions from all your traditional IRAs after you turn 70 and a
half years old. (The rule doesn't apply to Roth IRAs).
This annual withdrawal is called a required minimum distribution;
or, in tax jargon, an RMD.
The balance inside your IRAs stays tax-deferred,
but your annual withdrawals are taxable income.
The government has waited a long time
to start taxing this money, and it's not fooling around: There's a steep
penalty for failing to take your annual RMD. The fine is equal to 50% of the amount you should have taken out of
the IRA, but didn't. In other words, if your RMD was $1,000 and you didn't take it, the fine is $500.
The deadline for taking your first RMD is April 1 of the
year after you turn 70 and a half. (Leave it to Congress to come up with such a
cockamamie deadline!) If your birthday is January 1 1950, for example, you'll
turn 70 and a half in June of 2021. That means your deadline for taking your
first RMD would be April 1 2022.
The deadline for each annual RMD from then on is December 31.
For many people, it makes sense to take their first RMD by
December 31 of the year in which they turn 70 and a half instead of waiting until the
following April 1. The reason: If you wait until the following April, you’ll
wind up having to take your first and your second RMD in the same calendar year --
and depending on how large they are, that could push you into a higher tax
bracket.
So how do you calculate your RMD?
To find out how much you must withdraw, you add up the total balance of all your
traditional IRAs at the end of the previous year, and divide that amount by your life expectancy.
In
our hypothetical example, you'd use your total IRA balance on December 31 2020 --
the year before you turned 70 and a half. To find your life expectancy, you'd look at an IRS actuarial table called the
Unisex Uniform Lifetime Table. You'll find it in the Appendix of IRS
Publication 590, which you can download at www.irs.gov.
At age 70 the IRS says your life expectancy is 27.4 years. So if your total
IRA balance on December 31 2020 was $400,000, your first annual RMD would be
$400,000 divided by 27.4 -- or $14,598.54.
To keep things simple, let's round
that up to $14,600.
If you wanted to take the entire RMD by December 31 2021 instead of using April 1 2022 as your deadline, you could take it as a monthly $1,216.66 withdrawal starting in January 2021.
Of course, you can withdraw a lot more than the minimum if you want. There’s no maximum distribution limit. But everything you withdraw is taxable income for the calendar year in which you take it.
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