FPA Financial Planning Perspectives
Will you turn 70 1/2 this year? Assuming you have
retired, you will likely be required to soon start taking a minimum amount of
money out of your retirement accounts, and you need to make some important
decisions, preferably before the end of this year, regarding those
distributions.
The general rule for required minimum distributions is
pretty straightforward. You must begin taking a minimal amount of money out of
your regular individual retirement accounts (IRAs) and other qualified
retirement accounts, such as a 401(k), by the end of the year you turn 70 1/2,
or no later than April 1 of the following year. You must continue to make
minimum withdrawals no later than December 31 every year thereafter, until your
death or you drain your retirement accounts. You’ll pay income taxes on all
earnings and pre-tax contributions at your regular income-tax rates.
Say you turn 70 1/2 on October 1 of this year. Then
you must start making minimum withdrawals by April 1, 2001. However, if you
turn only age 70 on October 1, you can wait until April 1 of 2002, because you
won’t be 70 1/2 until 2001.
Just so the rule isn’t too straightforward, there are
exceptions to this general rule. One big exception is that you don’t have to
take minimum distributions from a Roth IRA at any time up to your death. You
can pass it on to your heirs, who in turn will have to begin minimum
withdrawals.
You also don’t have to start taking minimum
withdrawals from your current employer’s qualified retirement plan if you are
still working at age 70 1/2. You can wait until you retire. However, you can’t
delay beyond age 70 1/2 if you own at least five percent of your employer’s
business. You also can’t delay distributions from a simplified employee pension
plan (SEP) or a savings incentive match plan for employees (SIMPLE IRA).
One of the next issues is whether you want to delay
starting the minimum distributions until April 1 after the year you turn 70
1/2. By waiting, the money has that much longer to grow tax-deferred, which is
usually a good thing. However, the strategy could boost you into a higher tax
bracket for the year. Say you wait until April 1 next year to take your first
distribution. Technically, that distribution is for the year 2000. Your next
distribution will be for 2001. You can’t delay that distribution into April 1
of 2002. That must be made by December 31, 2001. Consequently, you will have
made two minimum distributions in the same tax year. You’ll want to run the
numbers by your financial planner or tax advisor to determine whether the
increased earnings from the delay exceed the increased taxes. Usually it won’t.
Keep in mind several other key issues about starting
your required minimum distributions. First, you must select one of three
distribution options by the time you make your first required distribution.
Your choice, which is irrevocable, determines the minimum amount you must
withdraw each year. You also must choose either a single life expectancy or a
joint life expectancy, and a beneficiary, if you haven’t already. You can
change your beneficiary after distributions begin, but it cannot decrease your
minimum distributions.
There is no single best method for everyone, so you
want to review your options with your Certified Financial Planner practitioner.
The important point is to remember to make the choice, preferably ahead of
time. If you fail to make a choice, you’ll end up with the default option
outlined in the plan document.
Second, if you neglect to make your withdrawals by the
required beginning date, or you don’t take out enough, you’ll pay a penalty of
50 percent on the difference between what you took out and what you should have
taken out.
Third, understand that the minimum required
distribution rule is a minimum, not a maximum. That is, you can take out more
than the minimum required amount in any given year because you need or want the
money. You can empty the entire account at one time if you want. You’re not
locked in.
September 2000— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Rich Chambers, CFP, a local member in good standing of the FPA.
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