Contributing to traditional 401(k)s and individual retirement accounts earns you a valuable tax deduction during your working years. But in retirement, you will need to start withdrawing the money and pay income tax on it. Here’s how to minimize taxes and fees as you draw down your retirement accounts.
Avoid the penalty. Withdrawals from traditional retirement accounts become required after age 70½, and each distribution is taxed at your ordinary income tax rate. If you fail to take a required minimum distribution or you withdraw the incorrect amount, the amount you should have withdrawn is taxed at 50 percent, in addition to the regular income tax you owe on it. “For the amount that doesn’t come out, there is a 50 percent penalty, and on top of it is still taxes,” says Joyce Streithorst, a certified financial planner for Frisch Financial Group in Melville, New York. “You could see up to 90 percent of it disappear, depending on your tax bracket.” Account owners can take any number of distributions throughout the year, as long as the minimum required amount is met by Dec. 31 (or April 1 if it is your first year of required distributions). Although you are allowed to withdraw more than the required amount, you cannot apply the excess to a future required minimum distribution.
Delay 401(k) withdrawals if you are still working. If you are employed after age 70½ and don’t own 5 percent or more of the company you work for, your 401(k) plan might allow you to delay 401(k) distributions until you retire. However, you will still need to take required minimum distributions from IRAs and 401(k)s from previous employers after age 70½, even if you are not yet retired.
Avoid two withdrawals in the same year. If you turned 70½ in 2014, you need to take a required minimum distribution from your retirement accounts by April 1, 2015. Your first required minimum distribution is due by April 1 of the year after you turn 70½, but subsequent distributions are due by Dec. 31 each year. If you delay your first required minimum distribution until April, you will need to take two distributions in the same year, which could result in an abnormally high tax bill. “You really don’t want to take two in one year because then you might put yourself into a higher tax bracket,” says Dan Candura, a certified financial planner for PennyTree Advisers in Braintree, Massachusetts. “You want to space them out a little bit.”
Calculate your distribution. Your required minimum distribution is calculated by dividing your retirement account balance by an IRS estimate of your life expectancy. Sometimes a spouse’s age is also taken into account. The distribution must be calculated for each IRA you own, but the amount can be withdrawn from any IRA or combination of IRAs. A 403(b) plan also allows you to total the required minimum distributions and take them from any account or combination of accounts. However, withdrawals must be taken separately from each 401(k) account.
Roth IRAs don’t require distributions. Although you need to take withdrawals annually from traditional and Roth 401(k)s and traditional IRAs, distributions from Roth IRAs are not required in retirement. “There’s no [required minimum distribution] when they get to 70½, so they can leave it to their heirs,” says Kimerly Polak Guerrero, a certified financial planner and executive director of Polero ICE Advisers in New York. “Having a mixture of traditional and Roth can be very valuable in retirement because then you can tinker around a little bit in retirement with your income.”
More from U.S. News
10 Images That Will Motivate You to Save for Retirement
10 Ways to Reduce Taxes on Your Retirement Savings
How to Reduce Your 2014 Tax Bill By Over $1,000
Strategies for Taking Required Minimum Distributions originally appeared on usnews.com
