Required Retirement Plan Withdrawals
If you plan well, save diligently, invest wisely and live within or below your means, you may very likely find yourself in a position where you can allow your tax deferred investment to grow. After all, the longer you can avoid paying taxes on your capital, the faster it will grow. However, the IRS won’t wait around forever to get its hands on its “fair share” of your hard earned money. So, it established a requirement that you begin withdrawing funds from your retirement accounts (i.e., 401k, IRA), when you turn 70 ½. This is referred to as the Required Minimum Distribution rule, and you need to pay attention because it can cost you a bundle otherwise.
The rule says that, at age 70 ½ you are required to withdraw a minimum amount from your 401k or IRA based on the balance in the account and your life expectancy. So, if you have $1 million in your IRA, and your life expectancy (based on IRS tables) is 27 more years, your withdrawal rate will be $1 million divided by 27, or $37,000 per year. Of course, when you withdraw the funds you will be taxed at your ordinary income tax rate to satisfy the IRS. If you fail to withdraw the minimum you will pay a 50% penalty tax.
This can present a problem for some retirees who have saved well and don’t necessarily need to tap in fully to their qualified retirement plan, preferring to let their funds continue to grow tax deferred. An alternative would be to use a Roth IRA as your savings vehicle. Although you contributions are made with after-tax dollars, they grow tax free and they can be withdrawn tax free. In addition, there is no Required Minimum Withdrawal.