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 new rules, you must start taking required minimum distributions (RMDs) every year after age 73, or face steep IRS penalties. While the specifics can get complicated, the basics boil down to taking your RMD by the deadline and paying ordinary income taxes on the money. A financial advisor can help create a tailored IRA withdrawal strategy optimized for your situation.
IRA Withdrawal Rule Changes
The rules for cashing your IRA have gone through some significant modifications in recent years. The good news is that, generally speaking, they have become more liberal and loosened rather than tightened controls over withdrawals.
In particular, the SECURE Act 2.0 raised the RMD age from 72 to 73 for those who turn 72 in 2023. It had previously been raised from 70 1/2 to 72. This means now you can wait until April 1 of the year after which you turn 73 in 2023 to take your initial RMD.
Figuring Out How Much to Withdraw
Once you hit RMD age, you must start taking annual withdrawals from your traditional, SEP and SIMPLE IRAs by December 31 every year. The amount you must withdraw is based on your age, account balance and life expectancy factors set by the IRS in their Uniform Lifetime 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, 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 be sure to withdraw at least this month by the end of the current year.
RMD Exceptions and Taxes
Rules vary depending on the type of retirement account and specific circumstances. For instance, Roth IRAs are exempt from RMD rules, so you can leave your account untouched if you wish no matter what your age.
There are also different rules for inherited IRAs, including both traditional and Roth types. Beneficiaries who inherit IRAs have varying RMD requirements based on their relationship to the original account holder.
Taxation of IRA withdrawals after retirement is more straightforward. The IRS taxes all pre-tax money withdrawn from traditional IRAs as ordinary income based on your federal income tax rate.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 solid motives for make sure you withdraw money from your IRA in accordance with the rules. In particular, skipping or skimping on RMDs can be an expensive mistake. That’s because if you fail to withdraw the full RMD amount you calculated, the IRS levies a 50% tax on whatever portion you missed.
Beyond financial penalties, not following the RMD rules could leave you cash-strapped. Sticking to RMDs ensures you have 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. Their life expectancy factor per the IRS Uniform Lifetime Table is 26 1/2 years. Dividing their $132,500 balance by the 26 1/2-year distribution period gives them an RMD of $5,000 for the year.
This retiree only withdraws $3,000 that year, however, exposing themselves to the required 50% penalty on the shortfall. In this case, the penalty would be 50% of $2,000 or $1,000. They still have to withdraw the $5,000, but they only receive $4,000 and still owe regular income taxes on that.
Making a Plan
To avoid costly penalties, make sure you understand the RMD rules. Carefully consult the IRS Uniform Lifetime Table annually to calculate what you must withdraw and make a plan.
You might also consider taking more than the minimum in low-earning years. For larger accounts, spreading withdrawals over the year prevents big swings in income.
The money in your IRA is yours to spend as you like, 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 steep financial penalties if you don’t withdraw the minimums. Following IRS rules prevents losing money, while smart planning help can minimize taxes and maximize your retirement income.
Retirement Planning Tips
Speaking with a financial advisor can ensure you take RMDs properly to avoid expensive IRS penalties. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s online retirement calculator to see how much you need to retire.
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