When and how to tap tax-deferred retirement plans

[June 23, 2011]  URBANA – If you have money in an IRA, a 401(k), or any other type of retirement plan, University of Illinois Certified Financial Planner Karen Chan says you should know the basic rules about taking money out of those accounts. If you don’t, you might pay penalties that could have been avoided.

“Your age at the time you take money out of retirement plans is the main factor that determines whether you can withdraw money without a penalty and whether you are required to take money out,” Chan said.

“You’ll owe income tax on distributions from tax-deferred, which are also called traditional, types of retirement accounts, because you haven’t paid tax on the money you contributed to the account or on the growth in the account,” she said.

Chan explained that you can delay taxes on distributions by transferring or “rolling over” the money into another retirement account. Only the required minimum distribution or distributions that are part of a series used to avoid early distribution penalties cannot be rolled over. Use a direct or “trustee to trustee” transfer to avoid complications.

Here are some details about how to avoid penalties based on your age:

-- If you are not yet 59 ½ years old, you will owe a 10 percent early withdrawal penalty on distributions unless you qualify for an exception. For most employer plans, you can avoid the penalty if you no longer work for the employer and you are at least 55 years old. If you are disabled or you need the money to cover medical expenses that exceed 7.5 percent of your adjusted gross income, you won’t have to pay the penalty. You can also avoid the penalty by committing to taking a series of substantially equal distributions for at least 5 years, or until age 59 ½, if that is later.

--If you are between 59 ½ and 70 ½, you are free to do as you please with the money in your tax-deferred accounts. There is no penalty if you take distributions, but neither are you required to take any money from the accounts.

--Once you reach age 70 ½, you must begin to take annual distributions from these plans. There is a grace period for the first distribution. You can take it anytime during the year in which you turn 70 ½, or you can delay it as late as April 1 of the following year. If you delay, remember that your second Required Minimum Distribution (RMD) will have to be made by December 31 of that same year, and both will be included in your taxable income for that year.
 

--If you work past age 70 ½, you may delay distributions from your current employer’s plans until you retire. This does not apply to plans of previous employers or IRAs. Also, owners of more than 5 percent of a company are not allowed to delay their minimum distributions past age 70 ½.

Your RMD is based on the balance in the account on December 31 of the previous year and your age. You can take more than the RMD if you want, but you will face a penalty if you take less. The penalty is 50 percent of the minimum distribution amount that you failed to take.

Chan said the financial institution that holds your account can calculate the RMD for you. But you can also calculate it yourself. Use the IRS Uniform Lifetime Table (Table III) found in the appendix of IRS Publication 590, Individual Retirement Arrangements. If your spouse is more than ten years younger than you, use Table II instead. Find the distribution period using your age (and your spouse’s age if using Table II). Divide that factor into the account balance. The result is your RMD.

Balances in your traditional IRAs are added together to determine your RMD, but you can take it all from one IRA or withdraw from several. If you have multiple 403(b) accounts, you can add those together and decide from which account(s) you want to take the RMD.

“Roth accounts have different rules,” Chan said. “If you are the owner of a Roth IRA, Roth 401(k), or Roth 403(b) account, there are no RMDs during your lifetime. After your death, however, your beneficiaries will be required to take annual distributions.”

[Karen Chan, News writer: Debra Levey Larson]

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