As you age, the rules for withdrawing money from your IRA change. For many years, retirees had to start withdrawing money after age 70 1/2. Under the new rules, you must begin taking required minimum distributions (RMDs) every year after age 73, otherwise face hefty IRS penalties. Although the specifics can be complicated, the basics boil down to making your RMDs by the deadline and paying ordinary income taxes on the money. A financial advisor can help create a tailored IRA withdrawal strategy customized to your situation.Thank you for reading this post, don't forget to subscribe!
Changes in IRA withdrawal rules
The rules for cashing out your IRA have undergone some significant amendments in recent years. The good news is that, generally speaking, they have become more liberal and looser on withdrawal controls rather than tightening them.
Specifically, the SECURE Act 2.0 raised the RMD age from 72 to 73 for those who will turn 72 in 2023. It was earlier increased to 72 from 70 1/2. This means you can now wait until April 1 of the year in which you’ll turn 73 in 2023 to take your early RMDs.
Figuring out how much to withdraw
Once you reach RMD age, you must begin taking annual withdrawals from your Traditional, SEP, and SIMPLE IRA by December 31 of each year. The amount you must withdraw is based on your age, account balance, and life expectancy factors set by the IRS in their Uniform Lifespan Table.
To calculate your RMD, you divide your prior year-end IRA balance by your life expectancy factor from the table. For example, if you are 73 years old, your life expectancy factor is 26 1/2 years. To get the RMD, divide the balance in your IRA at the end of the previous year by 26 1/2 and make withdrawals at least this month by the end of the current year.
RMD exceptions and taxes
The rules vary depending on the type of retirement account and specific circumstances. For example, Roth IRAs are exempt from RMD rules, so you can leave your account untouched if you want, no matter your age.
There are also different rules for inherited IRAs, including both traditional and Roth types. Beneficiaries who inherit an IRA have different RMD requirements depending on their relationship to the original account holder.
Taxation on IRA withdrawals after retirement is more simple. The IRS taxes all pre-tax money withdrawn from a traditional IRA as ordinary income based on your federal income tax rate. Roth IRA withdrawals represent exceptions. They are tax-free if taken after age 59 1/2 and the account has been open for at least five years.
Reasons to follow IRA withdrawal rules
There are some concrete objectives to ensure that you withdraw money from your IRA according to the rules. In particular, skipping or skimping on RMDs can be a costly mistake. This is because if you fail to withdraw the full RMD amount calculated, the IRS imposes a 50% tax on the portion you missed.
Apart from the financial penalties, not following RMD rules can leave you cash strapped. Sticking to RMDs ensures that you have the income to cover expenses now while preserving assets for future needs.
IRA Withdrawals in Action
To get an idea of how this works in practice, consider a retiree who turns 73 this year and has a $132,500 IRA balance. His life expectancy factor is 26 1/2 years, according to the IRS Uniform Lifetime Table. Dividing their $132,500 balance by the 26 1/2-year distribution period gives them an RMD of $5,000 for the year.
However, this retiree only withdraws $3,000 that year, causing him to suffer the required 50% penalty on the deficiency. In this case, the fine will be $2,000 or 50% of $1,000. They still have to withdraw the $5,000, but they only get $4,000 and still have to pay regular income taxes on that.
make a plan
To avoid costly penalties, make sure you understand the RMD rules. Carefully examine the IRS Uniform Lifetime Table annually to calculate how much money you should withdraw and make a plan.
You may also consider taking more than the minimum in low-earning years. For larger accounts, spreading withdrawals throughout the year prevents large fluctuations in income.
The money in your IRA is yours to spend as you wish, but you’re not allowed to leave it in a tax-advantaged shelter forever. With traditional IRAs, as well as some other retirement account types, required minimum distributions from IRAs must begin at age 73. To ensure compliance, the law provides for heavy financial penalties if you do not withdraw the minimum amount. Following IRS rules protects against losing money, while smart planning can help minimize taxes and maximize your retirement income.
Retirement Planning Tips
Photo credits: ©iStock.com/Inside Creative House, ©iStock.com/fizkes, ©iStock.com/Sladic