ATTENTION IRA OWNERS:
The IRS just gave you a gift, and it could easily be worth thousands of dollars in tax savings. You see, the tax man just surprised me and most other tax gurus by issuing new rules regarding the required minimum withdrawals that all traditional (i.e., non-Roth) IRA owners are required to start taking once they reach age 70 1/2. The changes were sorely needed, and should ultimately make tapping your IRA simpler and less costly. But that doesn't mean this transition year is going to be easy.
That's because while the new rules will become mandatory in 2002, they're optional this year. So for minimum withdrawals taken in 2001, IRA owners can pick either the "new rules" or the "old rules" (which have been around since 1987). Unfortunately, this means you need to understand both. But trust me, nearly everyone is going to benefit by selecting the new ones.
Minimum Withdrawal Basics
If you're near that magic age of 70 1/2, then you probably already know that the tax laws require you to take mandatory payouts each year. If you turned 70 1/2 last year, you must take your first minimum withdrawal no later than April 1 of this year. (That is, unless you're among the few who opted to take their first mandatory payout last year.)
Tapping your IRA, of course, means you'll also get stuck with the resulting income-tax bills. In fact, the whole reason your friends in Congress enacted the original minimum withdrawal rules was to force you to hand over the government's share of your IRA sooner rather than later.
Sadly, even under the new rules, you're still going to have to ante up to Uncle Sam. If you fail to take at least the minimum withdrawal amount each year, you'll owe a 50% penalty on the shortfall. Of course, you can always take out more than> the minimum and pay the extra income taxes. In fact, the IRS will be delighted if you do.
Before you get too depressed, let's get back to the good news: The new withdrawal rules are beneficial to nearly everybody. They essentially change the ways you must calculate your minimum withdrawals, and the net result is that you'll most likely be required to take out less> than you would under the current rules. You'll see what I mean when I give specific scenarios (see below). And, conveniently, starting next year, you won't even have to make these minimum withdrawal calculations yourself. Your IRA trustee will be required to report the minimum withdrawal amount to you instead. (Currently, IRA trustees don't have to do this, although some report minimum withdrawal numbers voluntarily.)
Keep in mind, the IRA minimum withdrawal rules also apply to simplified employee pension, or SEP, accounts, since they're considered IRAs for this purpose. But Roth IRA owners are exempt from the minimum withdrawal rules as long as the original account owner is alive.
When to Start Withdrawals
Since nothing the IRS does is ever simple, knowing when you need to start taking mandatory withdrawals, is but of course tricky. As you approach 70 1/2, you're faced with a choice. You can take your first minimum withdrawal during the year you turn 70 1/2, or you can take it by April 1 of the year after> you turn 70 1/2. Then for each subsequent year, you must take at least the required minimum withdrawal by Dec. 31 of that year.
Why does it matter when you start tapping your IRA? Well, it can have significant tax implications. After all, if you don't take your initial minimum withdrawal during the year you turn 70 1/2, you must take two and pay the resulting double dip of taxes in the following year.
Calculating Minimum Withdrawals
Under the new rules, the amount of each minimum withdrawal depends on your IRA account balance at the end of the previous year divided by a joint life-expectancy figure for you and your beneficiary (even if you don't have one!) found in tables published by the IRS. The younger you are, the longer the life-expectancy figure. The longer the life-expectancy figure, the bigger the divisor. And the bigger the divisor, the lower the minimum withdrawal amount. Of course, lower minimum withdrawals mean lower taxes which, obviously, is good.
The old rules required using your shorter single life-expectancy figures, that is, unless you designated your IRA beneficiary by April 1 of the year after turning 70 1/2. The problem with that was that many people forgot and missed the deadline. And even if you remembered the deadline and named your spouse as your IRA beneficiary, the old rules generally resulted in higher minimum distributions.
The new minimum withdrawal rules automatically assume you've designated a person 10 years your junior as your IRA beneficiary. Don't worry, it doesn't matter if your actual designated beneficiary is older than the assumed age. In fact, it generally doesn't matter if you've actually designated a beneficiary or not. This might strike you as odd, but there is some history behind it. (I'll spare you the titillating details.) All you really need to know is that it's probably the best set of tax-payer friendly assumptions you could hope for.
The only exception to the new "automatically-10-years-younger-beneficiary rule" is when your spouse is designated as the sole IRA beneficiary and he or she is more than> 10 years younger. In this somewhat unusual circumstance, you're allowed to calculate your IRA minimum withdrawals using more favorable joint life-expectancy figures based on the actual ages of you and your spouse. This is also a good deal. (The old rules said the same thing but again only if you remembered to designate your much-younger spouse as the IRA beneficiary by the April 1 deadline.)
Now, how these rules will affect you specifically depends on your age and how much money you have in your IRA. Click on the scenario below that applies to you: