Smart Strategies for Taking Required Minimum Distributions

Retirees who forget annual 401(k) and IRA withdrawals face huge penalties.

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After years of delaying income tax on your 401(k) and IRA contributions, Uncle Sam comes to collect in retirement. Distributions from 401(k)s and IRAs become required after age 70½, and you must pay income tax on each withdrawal. Here are some strategies for taking required minimum distributions that will help you preserve as much spending power as possible.

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Start after age 70½. Remembering to take these withdrawals is essential to your retirement security. You must take your first required minimum distribution by April 1 of the year after you turn 70½. Subsequent distributions are due by December 31 each year. The penalty for failing to take this distribution is a stiff 50 percent tax in addition to regular income tax on the amount that should have been withdrawn. "You're not saving yourself anything by not taking distributions," says Grace Cavanaugh, a certified financial planner for Cavanaugh Financial Group in Plymouth, Minn. "The penalty for not taking the right amount is severe."

Avoid two distributions in the same year. Retirees who delay their first retirement account withdrawal until April 1 will need to take two distributions in the same year because the second distribution will be due December 31. Withdrawals from 401(k)s and IRAs are taxed as income, and two withdrawals in the same year could significantly increase your income tax bill. "Take a look at what your taxable income is going to be and determine whether or not two distributions are going to kick you into a higher tax bracket," says Richard Donahue, a certified financial planner for Asset Advisors in Bellingham, Wash.

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Delay 401(k) withdrawals if you are still working. People who are still working after age 70½ can delay distributions from their current 401(k), but not IRA, until April 1 of the year after they retire. "If you are an employee, then you can continue to leave that money in the plan," says Donahue. However, employees who own 5 percent or more of the company sponsoring the plan must start 401(k) distributions after age 70½, even if they are still working.

Withdraw the correct amount. The distribution amount is generally calculated by dividing your account balance by an IRS estimate of your life expectancy. However, if you have a spouse who is more than 10 years younger than you and is the sole beneficiary of your IRA, your spouse's age must also be factored into the calculation. Retirees over age 59½ can withdraw more than the required minimum amount each year, but excess withdrawals will not count toward required distributions in future years. Retirees can take any number of withdrawals they choose throughout the year, as long as the minimum is met by December 31 (or April 1 if it is your first required distribution).

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Take distributions from the worst-performing account. If you have several IRAs, you must calculate the required minimum distribution for each account, but you don't have to take a separate withdrawal from every IRA you own. You can add up your IRA distributions and take it all out of one IRA or a combination of any IRAs you choose. "If you have three IRA accounts and they are paying you 1 percent, 3 percent, and 5 percent, my suggestion, in most cases, would be to take it all from the one that is paying you the least," says David Hutmacher, a certified financial planner and president of Southwest Seniors Financial in Scottsdale, Ariz.

Those with a 401(k) or most other types of workplace retirement accounts must take a withdrawal from each account. However, if you have multiple 403(b) tax-sheltered annuity accounts, you can total the required minimum distributions and take them from any account or combination of accounts.

Convert to a Roth. There are no minimum distribution requirements for Roth IRAs. Workers already paid income taxes on Roth IRA contributions, and the money can be withdrawn as you need it or can be passed on to heirs. "Once you have a Roth, then you don't have to worry about distributions," says Hutmacher. Having both Roth and traditional retirement accounts can add tax diversification and flexibility to your retirement draw-down strategy.