"I was absolutely shocked," says Eric, a retired engineer. "The IRS sent me a bill for over $14,000 for not withdrawing my required minimum distribution from my Fidelity IRA for 2010. Not only did I have to pay the ordinary income tax on the IRA distribution, but the IRS instructed me to pay another $7,100 for penalties and interest."
Failing to take required minimum distributions is a common tax trap for thousands of retirees each year. Don't let this happen to you.
Starting the year you turn 70 1/2 in a calendar year, and in every future year, IRS requires you to withdraw a minimum amount of money from traditional IRAs, roll-over IRAs, simple IRAs, most 401(k) and 403(b) plans.
When you were younger, it was fun deferring income into traditional IRAs and other retirement accounts. Retirement accounts can often minimize taxes, score bigger tax refunds, and, best
of all, allow earnings to grow tax-deferred.
Retirees over age 70 1/2 can't defer income forever because the U.S. government desperately needs tax revenue.
Worse yet, there's a nasty additional 50 percent excise penalty for failing to withdraw and report proper amounts from retirement accounts, like traditional IRAS and 401ks, on your tax return.
What's a retiree to do?
Simply calculate your required minimum distribution by dividing the market value of applicable tax-differed retirement accounts on Dec. 31 of last year by a factor from the IRS uniform lifetime expectancy table.
For example, if you're 71 with three IRAs worth $240,000 on the prior Dec. 31, your divisor from the table is 26.5. Now divide $240,000 by 26.5.
Result? Include $9,056 on your individual tax return. The IRS will fine you, an additional 50 percent penalty, of $4,528 in this example, for not withdrawing and paying tax.
Use caution, though. The IRS, unlike in the past, is becoming very vigilant in hitting taxpayers up for big taxes and penalties. Banks, mutual fund companies, and brokerage firms report the values of your IRA accounts directly to the IRS on form 5498. If no or an improper required minimum distribution is reported, the IRS will mail you a tax deficiency payment.
When it comes to required minimum distributions:
n Start taking required minimum distributions for the year you turn age 70 1/2. Withdraw the full amount of your required distributions no later than March 31 of the year following turning age 70 1/2. Then withdraw future required minimum distributions by Dec. 31 each year.
n Using a strategy to delay first IRA withdrawals to March 31 of the following year after turning 70 1/2 requires two withdrawals that year.
n You're not required to take pro-rata distributions from each IRA account. The total required minimum distribution can be withdrawn from one or more accounts.
n If you have failed to take amounts from IRAs, don't wait for the IRS to slam you with the 50 percent penalty. Amend tax returns or request a waiver of penalty.
n Systematize and automate the process. Fill out forms to ensure your funds are withdrawn timely and sent to you each year. Each year, of course, remember to adjust multiples.
Jim Germer, a Bradenton CPA and financial adviser, can be reached at 941-746-5600 or firstname.lastname@example.org.