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Payoff Time: How to Take Money Out of Your IRA

You've saved and saved. At age 70 1/2, you must start withdrawing. Here are the issues you'll face.
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Whether you look at IRA distribution time as a last inning, fourth quarter or achieving a summit, by age 70 1/2 at the latest you'll be making one of the most important decisions of your financial life: How to take your money out of the IRA.

You'll be forced to answer questions like:

  • When do I have to make the decision?
  • When do I have to take my first distribution?
  • Should I take it the first eligible year or wait until the second?
  • Who should my beneficiary be?
  • What happens if I die?
  • How can I minimize the taxation of my IRA?
  • What method of calculation should I use to determine my distribution?

I'll try to help you answer these and other questions today and in the next couple of columns. Please note: I won't be covering investment strategy, setting up IRAs or Roth IRAs. In other words, I am not discussing the accumulation of IRA assets. Instead, I'll look at the back end: When and how to take your money out.

Let's start with the "when." You can begin taking distributions from an IRA without penalty at age 59 1/2. Before that point, distributions are subject to a penalty tax of 10%. That's 10% in addition to the regular tax you have to pay on the money you take out.

From age 59 1/2 to 70 1/2, you can take out as much or as little as you want without penalty. You simply have to pay the tax on the distributions at your ordinary rate. It is at age 70 1/2 that the rules get a bit more confusing and you are forced to start taking distributions.

Minimum distribution rules have been devised as a tax penalty provision to prevent owners and their beneficiaries from totally deferring IRA benefits and thereby transferring them, free of income tax, to the next generation. The purpose of these rules is to "force" a given amount into current income each year. You saved and invested for years on a tax-deferred basis, and now the government wants you to "pay up" in the form of taxes.

Under the government's tax rules, there are three relevant points to consider in satisfying the minimum distribution rule.

  • Determining the required beginning date to start distributions.
  • Valuing the amount of minimum distribution.
  • Making a beneficiary designation.

When Distributions Start

The date IRA distributions must begin being paid is April 1 of the calendar year following the year the IRA owner turns 70 1/2. The payment then actually applies to the year the IRA owner turned 70 1/2.

For example, if you turned 70 1/2 on June 17, 1998, the required minimum distribution for 1998 can be delayed until April 1, 1999. But you might be better off taking the payment in the calendar year you turn 70 1/2. This would avoid the "bunching" effect -- and the tax burden -- of receiving two payments in a single calendar year.

Calculating the Minimum Distribution

There are two methods for determining your minimum distribution amount, non-recalculation or recalculation. You must chose one method and live with it. Your decision is irrevocable. In both cases, the calculations begin with the value of your IRA account on Dec. 31 of the calendar year before you turn 70 1/2 and use actuarial tables to determine how much will be distributed.

The non-recalculation method simply determines how much longer you're likely to live, according to actuarial tables, and pays out enough of your IRA proceeds so that you'll have exactly zero left at the end of that period. So, if the tables say you'll live another 20 years, you'll take 1/20 of your IRA as a distribution in the first year, another 1/20 in the second year, and so on. At the end of 20 years, your IRA account will zero out.

The recalculation method also looks at actuarial tables, but allows you to recalculate the amount each year. Since actuarial calculations of your life span will change from year to year, this will not result in the even payment schedule of the non-recalculation method. In fact, it will stretch out the payments. Using this method, you won't outlive your IRA distributions. There are many reasons you might want to stretch out your payment schedule, and we'll examine some of them in next week's column.

In either case, you probably won't have to make these calculations yourself. Your IRA custodian or accountant should do it for you.

Choosing a Beneficiary

You can make your beneficiary your spouse or almost anybody else. If your beneficiary is significantly younger than you are, it will have the effect of stretching out your payment period since actuarial tables will take into account the combined life expectancy of you and your beneficiary.

One key point: You can only stretch out payments so much by choosing a young beneficiary. Even if you choose your 3-year-old grandchild, the law will recognize a maximum age difference of just 10 years.

I welcome your

comments and questions. I cannot answer specific questions but I may be able to address some in my column. Be sure to get appropriate tax and legal advice before making any final decisions. Have a happy and healthy week.

Vern Hayden is a certified financial planner in Westport, Conn. He is a financial consultant and advisory associate of Financial Network Investment Corp. He also is an owner of Hayden Financial Group. His column is not a recommendation to buy or sell stocks or to solicit transactions or clients. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks or funds. While he cannot provide investment advice or recommendations, Hayden welcomes your feedback at