Study tax implications before that first IRA withdrawal

Dollars & Sense

April 13, 2003|By Neil Downing | Neil Downing,PROVIDENCE JOURNAL

I've received a letter from my bank telling me that I must begin to withdraw my IRA. I am a person who was born on July 26th, 1932. I'm still employed; I work for myself as a real estate appraiser; I am constantly at work . . . I say I won't be 70 until July 26th of 2003, and 70 1/2 would be later.

It is prudent to be thinking about this, said Marvin R. Rotenberg, national director of retirement services at Fleet Bank's Private Clients group, and a widely regarded authority on IRAs and other retirement plans. If you fail to make the required withdrawal from your traditional IRA, or if you don't withdraw enough, you could trigger a steep penalty.

To answer your question directly: You did, indeed, turn 70 last year, but you didn't turn 70 1/2 until this year. As a result, you won't have to make your first required withdrawal (technically called a required minimum distribution) until early next year.

Nevertheless, you may want to make that first withdrawal this year, to avoid tax complications.

If you own a traditional IRA, the general rule is that you must withdraw a minimum amount each year once you turn 70 1/2 , and you must make the withdrawals by Dec. 31 of each year.

But for that very first withdrawal, there's a special rule: you have the option to postpone it a few months beyond Dec. 31. (Technically, it must be done by April 1 of the year after the year in which you reach 70 1/2 .)

So how does all this apply in your particular circumstances? People like you, who were born on or after July 1, 1932, turn 70 1/2 this year. As a result, you don't have to make your first required withdrawal by Dec. 31 of this year; you can put it off until early next year, Rotenberg said.

But consider talking with an accountant, enrolled agent or other tax professional about the impact this decision will have on your taxes. Why? In general, each dollar you withdraw from a traditional IRA will trigger income tax.

If you postpone your first required withdrawal until early next year, you'll still have to take your second required withdrawal by Dec. 31 of next year. As a result, you'll have two withdrawals in the same tax year, said Mark S. LaVangie, senior wealth strategist at Fleet's Private Clients group who works with Rotenberg on IRA and related matters.

Depending on how much those withdrawals total, you could be bumped into a higher tax bracket next year, he said. (In addition, if you receive Social Security benefits, you might subject some part of those benefits to tax.)

To spread out the tax impact, you might think about making that first withdrawal by Dec. 31 this year (even though you technically don't have to), and make the second withdrawal by Dec. 31 next year.

In your question, you mentioned that you're still working. But keep in mind that you still must make mandatory withdrawals from your traditional IRA even if you continue to work. (Under certain conditions, you may postpone mandatory withdrawals from 401(k) and other such plans while you're still working - even if you're older than 70 1/2 .)

Congress is considering the possibility of gradually raising to 75 the age at which you must start mandatory withdrawals from a traditional IRA, but hasn't made the change yet.

The government wants IRA trustees and custodians (such as banks and other financial institutions) to formally advise you when a mandatory withdrawal is required.

In general, the financial institution must send you a statement which lists the amount you must withdraw and your deadline. (In the notice, the financial institution may simply let you know that a withdrawal is required and offer to calculate it for you. (These rules are important because if you fail to make the right withdrawal on time, you could face a penalty. The penalty is 50 percent of the difference between what you should have withdrawn and what you did withdraw.)

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