Normal distributions from your IRA are allowed after you reach 59½, the age when you are able to make voluntary withdrawals. However, once you have reached the age of 70½, you are legally required to take distributions. There are IRS formulas that will help you determine how much you must withdraw after you reach 70½.
The 10% penalty tax
If you take a premature withdrawal before 59½, you will be charged a 10% penalty tax on top of the regular income taxes you'll owe on the amount withdrawn. However, you can withdraw without penalty under any of the following exceptions:
Although complicated, being familiar with tax rules will make withdrawing your IRA money much easier and more cost-effective.
There are three ways you can take distributions from an IRA.
If you are older than 70½
If you are older than 70½, there is a minimum distribution requirement in an amount equal to the balance of your account divided by your current life expectancy. This amount is adjusted each year for your attained age.
How you elect to receive your IRA distributions will probably be determined by how your IRA fits in to the rest of your retirement income, especially when it comes to taxes.
An annuity is a contract with an insurance company that takes the funds you have built up for retirement and makes payments to you based on a distribution method of your choice.
There are four annuity distribution methods:
To determine your required annual minimum distribution, you may simply divide your retirement account balance by a single or joint life expectancy factor. You can use a life expectancy table such as those found in IRS Publication 590. The following is a small segment of an IRS life expectancy table:
Recalculating your required distribution annually
You may choose to recalculate your required minimum distribution annually. If you recalculate, each year's required minimum distribution will be based on your life expectancy that year. If you choose not to recalculate this figure annually, you simply subtract one from your life expectancy every year following the first year you begin receiving distributions. Recalculation generally lowers your payments because, when you live another year, your life expectancy increases.
You also may determine your required minimum distribution through amortization, which is another way to liquidate your assets through periodic payments containing both interest and principal. This is the method you may have used to pay off a home mortgage loan. Amortization involves choosing a reasonable interest rate—often in the 5–10% range—and prorating the account balance across a fixed period using the rate and life expectancy tables. You can do the computation using the financial calculator built into many spreadsheet programs or available at various financial websites.
The distribution plan you choose can also affect your estate planning and the taxes your heirs will pay. Be sure you understand your options before you sign your annuity contract.