​​Drawing down your retirement account

Most articles about Individual Retirement Accounts (IRAs) focus on the benefits of starting one – most notably allowing money to grow tax-free until retirement.

Much less attention is paid to the back end.

However, the way one structures withdrawals – “distributions” in financial parlance – is very important. The rules can be complex, but failure to comply could result in losing those lifelong gains to taxes and penalties.

Except with Roth IRAs (which I’ll discuss in a moment), you can’t keep money in tax-deferred retirement accounts indefinitely. Generally, you must start withdrawing funds by the end of the year in which you turn 70.5 years old. (In some instances, however, withdrawing at age 70.5 may be delayed; for example, if you are still working and the funds are in the retirement plan of your current employer. I recommend speaking with your financial professional to clarify these instances.)

These annual “required minimum distributions” (RMDs) are subject to taxes; the idea is that you will be in a lower tax bracket after retirement than when you were working. Your RMD – the minimum amount you must withdraw annually – is your account balance at the end of the previous year divided by your life expectancy per the IRS’s Uniform Lifetime Table. Many financial websites can help you calculate your RMD, but you can schedule the payments anytime during the year.

I generally suggest waiting until December to withdraw the money so that it remains invested the whole year – hopefully earning interest or capital gains throughout. But circumstances vary from person to person; some folks need the income and chose quarterly or monthly distributions.

Failing to take an RMD results in a penalty equal to 50 percent of what you should have withdrawn.

Inherited IRAs

Earlier I mentioned the Uniform Lifetime Table. This budgeting for life expectancy begs the question: What if money remains in your retirement account when you die? This is where things can get really complicated.

First, make sure you have specified beneficiaries for your retirement accounts. Understand that, in most cases, they won’t just get a check for the full amount left to them, which could expose them to hefty taxes. More likely, the inheritances will go into IRAs controlled by the beneficiaries – with most of the same rules as the original account.

There are four ways a beneficiary can handle an inherited IRA:

1. A surviving spouse can transfer the balance straight into an existing or new IRA in his or her own name, but must wait until age 59.5 to make withdrawals without penalty. I recommend this almost always for surviving spouses – who, in Arizona, must be the primary beneficiary unless he or she specifically opts out.
2. If there are other beneficiaries, their best option usually is the life-expectancy method. These non-spousal heirs transfer their shares into their own “inherited IRAs.” The RMDs would be based upon the age of the oldest beneficiary. Distributions must begin by the end of the next calendar year following the one in which the deceased passed away. For example, if the individual passed away on Nov. 20, 2016, the RMDs would have been calculated based upon the value of the account on Jan. 1, 2017, and must’ve begun in 2017.
3. Then there is the five-year method: The assets are transferred to an inherited IRA but must be distributed (and taxed) by the end of the fifth year following the one in which the benefactor died. Because the distributions could push the beneficiary into a higher tax bracket, I usually reserve this strategy for minors, who expect to be in school, and not generating other income, during the five years.
4. Finally, a beneficiary could cash out the inheritance in a lump sum, but that could bring a big tax hit and forfeit future tax-deferred gains.

Between their own retirement savings and what they have inherited, it’s not uncommon for beneficiaries to have multiple accounts, each with its own RMD and withdrawal schedule.

Roth IRAs

Unlike traditional IRAs, Roth accounts do not require distributions until the account holder’s death. Inheritance options for a Roth IRA are the same as above, except that the principle is not taxable and the gains are not taxable if the deceased held the account for at least five years.

The biggest takeaway I’d like you to have from this column is to be aware of what’s coming. Structuring the back end of a retirement account is complex because there are so many rules and variables. A financial professional can help you make plans based upon the income and tax situations facing you and your heirs.

This article was written by Adam B. Carlat, a Glendale-based financial adviser and Chartered Retirement Planning Counselor^® with One2One Wealth Strategies. Questions? Call (623) 850-0016 or email adam@121ws.com. 

The above example is a hypothetical and for illustrative purposes only. Please note that each person’s situation is different. Please consult your financial or tax professional regarding your circumstances.

The opinions expressed in this article are those of Adam Carlat and are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your tax, legal and/or financial services professional regarding your individual situation. The views expressed in this letter are those of the author and may not necessarily reflect those by PlanMember Securities Corporation.

Representative registered with and offers only securities and advisory services through PlanMember Securities Corporation (PSEC), a registered broker/dealer, investment adviser and member FINRA/SIPC. 6187 Carpinteria Ave, Carpinteria, CA 93013 • (800) 874-6910. One2One Wealth Strategies and PSEC are independently owned and operated companies. PSEC is not liable for ancillary products or services offered by this representative or One2One Wealth Strategies.