Planning is needed to help build the biggest possible nest egg in your traditional IRA (including a SEP-IRA or SIMPLE-IRA). In addition, it’s even more critical that you plan for the eventual withdrawals from these tax-deferred retirement vehicles.
There are three areas where knowing the technical points of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:
There may be reasons you consider taking money out of a traditional IRA before age 59½. For example, you may need money to pay your child’s education expenses, make a down payment on a new home, or meet necessary living expenses in early retirement. Since traditional IRAs offer “tax-deferred” growth, this means taxes are simply delayed until you withdraw from the account. In these cases, any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, IRA withdrawals before age 59½ may also be subject to a 10% penalty tax. However, there are several ways that the 10% penalty (but not the regular income tax) can be avoided. For example, if distributions are made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary, the penalty does not apply. Seek professional tax advice if this early IRA payment plan is to be considered so you are fully aware of the rules. Before deciding if an early distribution makes sense, it’s important to weigh the cost-benefit of taking the withdrawal.
The decision concerning who you want to designate as the beneficiary of your traditional IRA is critically important. This decision affects the minimum amounts you must generally withdraw from the IRA when you reach age 72 and it also determines what remains happens to the account at your death as well as how quickly the IRA balance must be paid out. What’s more, a periodic review of the individual(s) you’ve named as IRA beneficiaries is vital as your life progresses or you have relationship changes throughout life. It’s also a wise idea to plan both primary and secondary beneficiary individual(s). If your primary beneficiary does not survive you or decides to decline the inherited funds (the tax term for this is a “disclaimer”), then your secondary beneficiaries (also called “contingent” beneficiaries) will receive the assets. Making decisions on beneficiaries and reviewing them periodically helps assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, as well as in your personal, financial, and family situation.
Required Minimum Distributions (RMDs)
Once you attain age 72, mandatory distributions from your traditional IRAs must begin. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax on what should have been paid out.
SPECIAL RULE FOR 2020: For 2020, the CARES Act suspended the RMD rules — including those for inherited accounts — so you are NOT required to take RMDs this year if you don’t want to. Beginning in 2021, the RMD rules will kick back in unless Congress takes further action.
In planning for required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.
It certainly may seem easier to put money into a traditional IRA than to take it out; however, this is one area where expert guidance is essential. Please contact your Wegner CPAs tax specialist with your traditional IRA questions and to analyze other aspects of your retirement planning. We can also discuss whether you can benefit from funding a current year Roth IRA (or a Traditional IRA-to-Roth IRA “conversion”), which operates under a different (more tax advantageous) set of rules than traditional IRAs.