59½ [60-70] 70½
Since insurance company actuarial tables consider you already 60 when you reach 59½, and still 70 until you’re 70½, Congress used those half-years to frame the withdrawal period from retirement accounts.
The first things you have to know about withdrawing from your tax-deferred individual retirement accounts are the magic numbers. One is the otherwise unmagical 59½. That’s the point at which you can begin to take money out of your account without paying a penalty.
Being eligible at 59½ doesn’t mean you must start withdrawing then: You can wait until you actually retire — at 62 or 65 or 68 — or until you’re ready to add a source of income to your budget.
The only restriction is that you must begin withdrawing from a traditional IRA by April 1 of the year following the year you reach 70½. In fact, you must take at least the required minimum distribution (RMD), based on your life expectancy and the value of your account, in every year from then on.
If you have a Roth IRA, you don’t have to set up a withdrawal plan, or make withdrawals at all, for that matter, if you don’t need the money. Remember, though, that your account has to be open at least five years and you have to be at least 59½ for the withdrawals to be tax free.
WHEN WITHDRAWALS ARE A MUST
The IRS doesn’t want a traditional IRA to be a way to build the estate you’re planning to leave your heirs. So after you reach age 70½, the law says you must start spending what you’ve saved — whether you need the money or not. One way to stretch the account (but not bend the rules) is to name a much younger person as your IRA beneficiary. When you die, that person may be able to spread payments from the account over his or her lifetime, extending the benefits for many years.
WHAT YOU HAVE TO TAKE
The rules on withdrawing from a traditional IRA are specific and much more simple than they used to be. Basically, you divide your account balance at the end of the previous calendar year by a number linked to your age. Those numbers are available in tables the IRS provides in Publication 590, “Individual Retirement Arrangements.” You can download a copy at www.irs.gov.
Everyone of the same age divides his or her account value by the same number, with one exception. If you name your spouse as beneficiary, and he or she is more than ten years younger than you are, you can use a different table, which uses a longer life expectancy and requires a smaller annual withdrawal.
If you don’t withdraw, or take less than you should, you are vulnerable to a 50% penalty on the amount you should have taken but didn’t.
THE TAX BITE
The tax you owe on your traditional IRA withdrawals is figured at your regular tax rate. That’s why some experts advise keeping investments you expect to grow in value, such as higher-risk stocks and mutual funds, in regular taxable accounts. You don’t owe tax on any increase in their value until you sell, and if you’ve owned them for more than a year, you owe tax at the lower capital gains rate. If your taxable investments are worth less when you sell them than they were when you bought them, you can use the capital loss to reduce other capital gains and even some ordinary income.
You may also want to consider whether to hold dividend-paying stocks in your taxable accounts if the dividends qualify to be taxed at your long-term capital gains rate. Most domestic stocks do qualify, and so do some distributions from certain mutual funds.
WHEN YOU CAN START WITHDRAWALS
Once you reach age 59½ you can start taking money out of your IRA in any amount you want. You’ll owe tax on the amount you withdraw from a traditional account, but you can spend it any way you like. With a Roth, there’s no tax at all provided your account has been open at least five years and you’re 59½.
TAKING IT EARLY
The government has done you — and itself — a favor by adding more exceptions to the rule against early withdrawals from your IRA. It won’t cost you a 10% penalty if you take money out of your IRAs to pay higher education expenses, put money down on your first home, or support your family while you’re disabled.
But you will owe taxes at your regular rate, giving the government added revenue. For example, a couple in their 40s who withdraw $100,000 from retirement accounts to pay their child’s college expenses could owe more than 45% of the withdrawal in combined federal and state income taxes.
Before you make that choice, you might compare what it costs to take a home equity loan, with its potentially tax-deductible interest, to the tax bill that comes with taking money out of your IRA. It may turn out that borrowing costs less. Another alternative is to tap your employer-sponsored retirement plans, by borrowing from your 401(k) or similar account. While the amount you can borrow may be limited, the interest you pay goes back into your account, helping to offset loss of potential earnings. Yet another option is to withdraw after-tax money you contributed to a Roth IRA. No tax or penalty is due on that amount, although the drawback is that it will no longer be accumulating earnings.
WHEN IT’S SAFE TO WITHDRAW FROM A TRADITIONAL IRA:
EARLY WITHDRAWAL WITHOUT PENALTY
There is one way to get access to the money in your IRAs before you’re 59½ and avoid the potential 10% penalty. That’s to annuitize your distribution. It means you establish a withdrawal plan that pays you, each year, a fixed amount of the money in your IRA, based on your life expectancy. The chief restriction is that the plan must cover at least five years or all the years left until you reach 59½, whichever is longer. Annuitization does have drawbacks, though. If what you really need is a large amount of money, you probably won’t get it this way unless you’re close to 59½. And you’re using money that was intended for your retirement, so you’re depleting, not adding to, your savings.