Mandatory IRA Distributions

Keeping your money in an individual retirement account (IRA) too long is worse than taking it out too early, as far as the IRS is concerned. If you have a traditional IRA, you must follow the required minimum distribution (RMD) rules. You must either receive the entire balance of your IRA or start receiving periodic distributions from it by April 1 of the year following the year in which you reach 70-1/2 (a.k.a. the required beginning date for IRA distributions). For any year after you turn 70-1/2, the required minimum distribution must be made by December 31 of that later year.

Example Ima Winner reached age 70-1/2 on August 20, 2012. For 2012 (her 70-1/2 year), she must receive the required minimum distribution from her IRA by April 1, 2013. She must receive the required minimum distribution for 2013 (the first year after her 70-1/2 year) and for each year thereafter by December 31 of each year.

The penalty for keeping your money in a traditional IRA too long is severe. An excise (penalty) tax of 50 percent is imposed on the amount that is not distributed as required. And, of course, the regular tax is imposed once a distribution is finally made. After the dust settles, you will be lucky to have a quarter of the required distribution amount to put in your pocket. At this rate, the odds of coming away with more money are better if you withdraw all your IRA savings and go on a gambling binge. (This is not a recommended option.)

Warning Given the importance of withdrawing at least the required periodic distributions, don't rely on the IRA custodian to figure out and inform you of how much to take out. There have been a number of cases where the IRA holder had to pay the ultimate price for an IRA custodian's mistake. Instead, figure out the required distribution amount yourself and build in an added cushion by withdrawing more. Another alternative is to withdraw portions (or even the entire amount) from a traditional IRA and deposit the amount into a Roth IRA until you need it.

Calculating periodic distribution amounts. If you decide not to receive the entire balance in your IRA by the required beginning date, you must start to receive periodic distributions over one of the following periods:

• your life;
• a period that does not extend beyond your life expectancy;
• the combined lives of you and your designated beneficiary (i.e., the person you name to receive your IRA upon your death); or
• a period that does not extend beyond the joint life and last survivor expectancy of you and your designated beneficiary.

Planning Tools You don't need a crystal ball to figure out the life expectancies you need. The IRS publishes a life expectancy table and a joint life and last survivor expectancy table for this purpose (in IRS Pub. 590). You can download these Life Expectancy Tables to aid in your financial planning.

To figure the required distribution for each year, divide the IRA account balance as of the close of business on December 31 of the preceding year by your applicable life expectancy or the combined life expectancy of you and your beneficiary. The IRA account balance is adjusted for any contributions or distributions that count for the year.

Financial Calculators The IRS requires that you withdraw at least a minimum amount, known as a required minimum distribution, from your retirement accounts annually, starting the year you turn age 70-1/2. Use this Required Minimum Distribution Calculator to calculate the amount that must be distributed. IRS rules allow for penalty-free withdrawals from retirement accounts. You may begin receiving money from your retirement accounts before you reach age 59-1/2, without the normal 10 percent penalty. Use this 72T calculator to determine your allowable 72(t) Distribution and how it can help fund your early retirement. When you are the beneficiary of a retirement plan, specific IRS rules regulate the minimum withdrawals you must take. If you want to simply take your inherited money right now and pay taxes, you can. But if you want to defer taxes as long as possible, there are certain distribution requirements with which you must comply. Use this Beneficiary Required Minimum Distribution Calculator to determine your Required Minimum Distributions (RMD) as a beneficiary of a retirement account.

If a beneficiary is other than a spouse and the beneficiary is more than 10 years younger than you, a minimum distribution incidental benefit (MDIB) table must be compared with the regular life expectancy table and the lower number used for the beneficiary's age.

Example Major League reached 70-1/2 in 2012 and must begin receiving distributions from his IRA by April 1, 2013. His wife and beneficiary, Ivy, turned 57 in 2012. Major's IRA account balance as of December 31, 2011, is $29,000. Based on their ages at the end of 2012, the joint life expectancy for Major (age 71) and Ivy (age 56) is 29 years. The required initial minimum distribution is $1,000 ($29,000 divided by 29 years) and is made from Major's IRA in 2013 by April 1. At the end of 2012, Major's IRA balance has grown to $29,725. To figure out the minimum distribution that must be made by the end of 2013, the $29,725 must be reduced by the minimum distribution amount for the previous year ($1,000) that was paid in 2013. Major's required distribution amount for 2013 is $1,026 ($28,725 divided by 28 remaining years). In 2014, the calculation will be made in similar fashion, using the IRA balance at the end of 2013 divided by 27 remaining years.

Multiple IRAs. If you have more than one traditional IRA, you have to figure out the required minimum distribution for each IRA. However, the total required distributions can be taken from any of the IRAs as long as the total amount is met.

Example Cara Lott turned 70-1/2 on February 1, 2012. She has two traditional IRAs, one with $10,000 and another with $20,000. Based on a 26.5 year distribution period for those age 71 from the applicable IRS Uniform Lifetime Table, the minimum amount that must be distributed from each IRA by April 1, 2013, is $377 and $755, respectively. Cara decides to have the entire $1,132 required distribution amount come from the smaller IRA because it offers a lower rate of return. After the required distribution is made, she is left with $8,868 in the first IRA and $20,000 remaining in the second. She can continue this process until the smaller account is depleted, then turning to the second IRA.

Charitable distributions from IRAs. Individuals aged 70-1/2 or older can distribute annually up to $100,000 of their IRA balance to charitable organizations without recognizing income. No charitable contribution deduction may be claimed, but the distribution counts towards the mandatory IRA minimum distribution.

This change is helpful for those who do not need to take distributions from their IRA, and who would prefer to avoid tax on the minimum required distributions that must be made with respect to a traditional IRA after the owner reaches age 70-1/2.

As with any tax law, there are some restrictions to keep in mind. A taxpayer can only take advantage of this provision by distributing IRA funds to a qualifying charity, which is a "50 percent organization" (so named because contributions to these organizations can be deducted up to 50 percent of the taxpayer's contributions base in the contribution year). These organizations include educational institutions, hospitals, medical research organizations, organizations supporting government schools, governmental units, publicly supported organizations, common fund foundations, private operating foundations, and conduit foundations.

However, not all 50 percent organizations qualify. Distributions to certain supporting organizations (i.e., organizations that support churches, educational institutions, hospitals, medical research organizations, organizations supporting government schools and publicly supported organizations) are not qualified distributions.