You have been fortunate enough to pile up savings in your Individual Retirement Account for all those years at work, and it's grown to a tidy sum. At age 70 1/2 , you need to start making withdrawals. Here is some good advice to avoid tax traps.
Remember that you have to make a withdrawal or face a hefty 50% tax penalty. You will owe taxes on the money you were supposed to withdraw, PLUS a 50% penalty. The withdrawal is called a Required Minimum Distribution (RMD). The first RMD is for the year in which you turn age 70 and 1/2.
But you can delay this first payment until April 1 of the next year.
Joe's celebrates his 70th birthday in April 2013 and is 70 1/2 in October. He doesn't have to tap the account until April 1, 2014, and figures, "I don't need the money now, so I will wait till next year."
Big mistake for Joe. He will have to take two RMDs next year, one for 2013 and one for 2014. And that can cost him a hefty sum in taxes. Let's say he was in the 15% bracket, filing taxes with his wife Sue, with joint income at $72,500, the very top of the 15% bracket. Each additional dollar of income places him in the 25% tax bracket.
And he waits till 2014 for the RMDs, which are $40,00o for each year. Therefore, for 2014, he will have an additional $80,000 in income, all subject to the 25% tax rate. His tax bill for the IRAs will be a hefty $16,400.
If Joe had taken the first RMD in 2013, his additional income would have been $40,000, and his taxes $10,000.
He would have saved $6,400. Don't make Joe's mistake, If you are 70 1/2 this year, get the money out before December 31.
What if you have multiple IRA accounts? Do you have to do lots of calculations and take a distribution from each one? No. You can add the total of all the IRAs to get the base for your distribution, and then figure what the total distribution will be. And then you can take that amount of money from any one of your IRAs or combination. Suppose your required withdrawal is $50,000, and you have seven different IRAs. You can take all $50,000 from one IRA, or $25,000 each from two IRAs or any combination. This allows you to look at your IRA investments carefully and decide on your best strategy for withdrawals,
IRA distribution rules are complex.
There is another way to save money on your IRA withdrawals, by making a charitable contribution.
It's called a Qualified Charitable Distribution (QCD). You can give up to $100,000 a year this way to fulfill the requirement for a minimum distribution for the year.
The money won't be taxable income for you and won't push you into a higher tax bracket.
Let's say Sam Smith has a required IRA withdrawal of $70,000 this year. He had a good year in the stock market, and is enjoying some hefty profits. The IRA withdrawal of $70,000 would push him and his wife Yvette into the 28% tax bracket, with income over $146,400 a year.
All that $70,000 would be taxable income, and his bill to the IRS for this withdrawal would be $19,600.
By making donation of $70,000 he saves almost $20,000, and he does $70,000 worth of good deeds.
Since the $70,000 doesn't count as income, it also CAN'T be counted as a charitable deduction on the tax return filed by Sam and Yvette.