Do You Know When You Can Withdraw From Your IRA? Are You Sure?

Now is the time of year when many investors rush to make contributions to individual retirement accounts. Although IRA investors have 15½ months to make contributions for a given tax year—from Jan. 1 through April 15 of the following year—the proportion of contributions made in that last half month is more than double that made in the first January, according to a recent analysis by Vanguard Group. But a subset of investors should be more concerned with taking money out of traditional IRAs right now: namely, those who turned age 70½ last year.

According to the tax law, from age 59½ to 70½ you are generally allowed to withdraw any amount you want from your traditional IRA without incurring a penalty or paying taxes on previously untaxed amounts. However, after you reach age 70½ you are required to withdraw a minimum amount every year or be subject to a hefty tax penalty. Ordinarily, the deadline for taking this required minimum distribution is Dec. 31st, but for your first distribution you are given until April 1st of the year following the year you turn 70½ to make the withdrawal.

Many investors make use of this three-month grace period. As of Dec. 31, 2013, some 40% of those required to take their first distribution had not yet taken the minimum amount, according to The Wall Street Journal in an article titled "Understanding Required IRA Distributions." That number of investors includes 14% who had not taken any distributions at all. If that is you, then the WSJ says you better get moving! If you miss the April 1st deadline, the IRS can penalize you up to 50% of the amount you were supposed to withdraw.

When do you take that initial required minimum distribution, and does that take care of all of that calendar year? It depends, the article says. If you turned 70½ last year and waited until this year to take all or part of your first required minimum distribution, you would still need to take your 2014 required minimum distribution by Dec. 31st of 2014. Likewise, withdrawals above and beyond the minimum in one year do not count toward required distributions in future years—you cannot apply it forward.

In which year is that first distribution taxable? The Wall Street Journal article says the basic answer is that the initial distribution is taxable in the year it is taken. So if you delayed taking it until 2014, the taxable portion of both your initial distribution and your 2014 distribution must be reported as income on your 2014 tax return. If those withdrawals are large enough, it could put you in a higher tax bracket this tax year. The financial institution that administers your IRA should be able to calculate your required minimum distribution and your IRA balance as of the previous year's end. Some IRA administrators will automatically calculate your required minimum distribution and then transfer it to an account of your choice, the WSJ says.

Can one have the financial institution that handles his IRA withhold the tax on his distribution, and, if so, whether the tax itself would still count toward his required minimum distribution amount? Yes to both parts of this question. In fact, unless you request otherwise, your IRA administrator must withhold federal (and, if applicable, state tax on your distribution), along with reporting withdrawals and any taxes withheld to you and the IRS on Form 1099-R.

Questions about IRA distributions, tax ramifications, and planning for retirement should be directed to an experienced estate planning attorney.  He or she will be able to help you put together the best strategy based on your needs and objectives.