Many investors dutifully save a portion of their hard-earned money every year in a traditional IRA. Then, they get to a point in their life when they want to use the accumulated IRA savings.
But how do you get out what you saved? What are the IRA withdrawal rules? How do you calculate and determine your IRA required minimum distributions? What happens if you need to make an early withdrawal from an IRA?
The IRS Has Specific IRA Withdrawal Rules
- Rule #1: You can start taking money out of your IRA at age 59 ½ without penalty.
- Rule #2: You must start taking required minimum distributions by age 70 ½, or by April 1st of the following year. All subsequent IRA required minimum distributions must be taken by December 31st of each year.
- Rule #3: Early withdrawal from an IRA before age 59 ½ means you will pay a 10% penalty, no exceptions.
Calculating your Required Minimum Distribution
Required Minimum Distributions (RMD) are actually not that complicated to figure out. Take the Fair Market Value (FMV) of your IRA on December 31 of the previous year and divide it by the IRS Minimum distribution incidental benefit (MDIB) factor. The MDIB factor is based on the age you will obtain on December 31st of the current calendar year.
Most financial institutions, brokerage firms and registered investments advisors do this calculation for their clients every year. And, the IRS even has created a handy worksheet to help you which is available on their website at: IRA Required Minimum Distribution Worksheet
Although you must take at least your required minimum distribution each year, you can take more. However, if you take more one year, it has no impact on your IRA distribution requirements for later years.
What if you have more than one IRA or an active 401(k)?
Your required minimum distribution (RMD) withdrawals need to be based on the total value of all of your IRA accounts. However, you can withdraw the funds from one source (ie. one of your IRAs).
If you are still actively employed at the company that administers your 401(k), you may not need to make withdrawals until you retire (or if you are a 5% owner in the company). With 401(k)s, your required minimum distribution is based solely on the individual value of each account. So, if you have more than one 401(k) account, you’ll have to take a separate withdrawal from each.
Penalties and Taxes on your RMD
The IRS penalty for not taking your required minimum distribution is severe – a 50% penalty on the withdrawal you failed to take. If you miscalculated, there is a form you may file to ask forgiveness (and a refund of the fine). It is, of course, up to the IRS to accept your remedy.
Normal IRA distributions (taken above age 59 1/2) are taxed at the account owner’s income tax rate although there may be exceptions that you can discuss with your accountant or CPA. (NOTE: Roth IRAs are very different. Because the money paid in is after-tax dollars, you are not required to make required minimum distributions, and withdrawals are not taxed.)
Do Other Accounts Have Required Minimum Distributions?
Many of the rules for required minimum distributions for IRAs also apply to your 401(k), 403(b) and 457(b) plans as well. Remember, these are pre-tax dollars that have been saved and invested so you pay taxes when you withdraw money from these accounts. However, because the withdrawals are treated as ordinary income, you do not have to keep track of gains or losses from the investments themselves.