6 Tips on Retirement Account Withdrawals

If you're not careful, failing to take money from an IRA can cost you big.

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Notify your heirs. Even death doesn't eliminate required distributions. Beneficiaries of your retirement accounts must take them by the end of the year of death to avoid penalties, if the RMD had not already been taken that year. The first distribution amount is based on the age of the deceased IRA owner. The beneficiary's age is used thereafter.

If there are multiple beneficiaries, the account should be split into separate inherited IRAs by the end of the year following the year of death. That way, each person can use his or her own life expectancy for calculating distributions, Slott says. If this isn't done, the age of the oldest beneficiary is used to calculate distributions, which typically means higher taxes for the younger beneficiaries. And although Roth IRA owners do not have to take required minimum distributions during their lifetime, beneficiaries other than the spouse do. The distribution is still tax free.

Consider donations to nonprofits. If you don't need the money, one way to avoid additional taxes is to donate your distribution of up to $100,000 to charity. But hurry: This provision of the Pension Protection Act expires on Dec. 31, 2007. If you transfer your RMD directly to your favorite charity, you don't have to pay income tax on that amount, says Mary Baldwin, a certified financial planner in Melbourne, Fla. "Most of my clients love to give. We send it straight to their church or Habitat for Humanity."

Colleges are a major beneficiary of these tax-free donations from IRAs and often solicit such gifts. "By naming us as beneficiary of your IRA, you can leave us a gift that is free of all income and estate taxes because we are a charitable organization," the website of Drake University reminds alumni and prospective donors, along with an example of a 73-year-old woman who turns over a $15,000 required distribution from her IRA to the university to avoid paying taxes on that income. The catch: You can't use these donations as a charitable deduction elsewhere on your tax return. "When you gift your IRA to charity, you don't get a charitable deduction for the distribution," Barton says. "I've found a lot more people wanting to get that deduction."

Save your distributions. Of course, just because you must take money out of your IRA and pay income tax on it doesn't mean you have to spend it. If you don't need the money for immediate expenses, you can still save it for use further down the road when you might. "I try to position at least two years' worth of those distributions in a safe place such as a money market fund," Barton says. "I think it gives people a sense of confidence and a peace of mind to know those dollars they are going to have to take from their portfolio are in a very safe place."