What You Must Do If You’ve Reached Age “70 ½” This Year?

Dear Relaxing Retirement Member,

As we move closer the end of 2010, it’s a good time to give you a reminder so you don’t subject yourself to a 50% penalty tax.

As you may or may not know, if you’ve reached the age of 70 ½, the IRS mandates that you withdraw money from your IRA and pay income taxes on it.

And, if you don’t, in addition to being subject to regular ordinary income taxes, whatever amount you were supposed to withdraw is also subject to a 50% excise tax!

Yes, you read that correctly. If you are required to withdraw $50,000 this year to satisfy your Required Minimum Distribution (RMD), and you fail to do so, in addition to ordinary taxes, you will also have to pay an excise tax of $25,000!

That doesn’t sound like a good plan, so let’s talk about how to do this correctly.

The first area to understand is that all money that you put away on a tax deferred basis, including your IRA, 401(k), 403(b), Profit Sharing Plan, SEP, Keogh, Simple Plan, etc. is subject to this RMD.

The only exceptions are balances in Roth IRAs, and the balances in your employer sponsored retirement plan while you’re still employed there (as long as you have less than a 5% stake in the company).

However, once you leave employment, all employer retirement plan balances are subject to this mandate.

How Much Do You Have To Withdraw?

In the year in which you turn 70 ½ or older, tally up your year-end balances in all eligible plans from the prior year.  So, for example, if you turn 70 ½ this year (2010), you would tally up all the balances in these plans as of December 31, 2009.

To arrive at the amount you must withdraw and pay taxes on, you then have to divide your total balance in all of these plans by your life expectancy (as outlined in the IRS life expectancy tables).

For example, if you’re 70 ½ years old this year, and the balance of your IRAs on December 31, 2009 was $1,000,000, you divide $1 million by your joint life expectancy at age 70 ½ (27.4 years) to arrive at the amount you must withdraw and pay taxes on: $36,497.

The amount you arrive at must then be withdrawn from one or all of your accounts by April 15th of the year following the year you turn 70 ½.

However, rarely is it a good idea to wait until then.  Unless there are some extenuating circumstances, plan on taking your first distribution during the year you turn 70 ½ so you don’t have to take 2 taxable withdrawals the following year.

Where Should You Withdraw The Required Amount From?

A key point to note is that you don’t have to withdraw a pro-rated portion from each account.  As long as you withdraw the total required amount, the IRS doesn’t care which account you withdraw the money from.

In other words, if you have $1 million in IRAs, a Keogh, and a SEP, you can withdraw the required amount from just one account, or from all three.

Finally, you may take the mandatory withdrawal from your retirement account in installments or all at once.  As long as you withdraw the total amount by December 31st of the year in which you must take the mandatory withdrawal.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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