Substantial Penalty For Messed-Up Withdrawal

By Martha M. Hamilton
Sunday, June 10, 2007

Sometimes I write about topics that I find a little difficult to get my arms around.

It was that old sense of responsibility that led me finally to grapple with required minimum withdrawals from retirement savings accounts in a column in April.

And it turns out that I wasn't the only one who found the subject confusing. I got e-mail after e-mail from readers wanting to know more about this topic, which sounds arcane but can make life really difficult if you don't figure it out.

So I promised to get some more answers, and I have. But first the basics:

There's a turning point in your retirement savings life at age 70 1/2 when, instead of encouraging you to save money for retirement, the tax code tells you to cash it out.

That's when required mininum withdrawals kick in and the Internal Revenue Service demands those taxes you've been deferring. Get it wrong, and the IRS will take 50 percent of the amount you should have withdrawn -- on top of the taxes.

You have to start drawing from any regular IRAs or workplace savings plans such as 401(k) plans when you turn 70 1/2 (unless you're still in the workplace). You don't have to take money out of Roth IRAs because you paid taxes on that money at the outset.

The deadline for taking your first distribution is April 1 of the year after that magic half-birthday. The amount you are required to draw is determined by life-expectancy tables published by the IRS. Your required minimum distribution is the amount in your retirement accounts divided by the IRS's figures on projected longevity.

The tables aren't that easy to find, as I pointed out. Several readers e-mailed to say, don't bother: Your IRA custodian or custodians will send you a notice saying how much you have to take out. And that's right, they are supposed to once you turn 70 1/2 . But they don't always, and also, if you're in your 40s, 50s or 60s and want to get some idea how much you may be required to draw, you'll have to look at the IRS tables.

Some IRA custodians (by which I mean mutual fund companies, banks and other institutions where you have invested in retirement accounts) are confused themselves about the rules, according to readers and to Bill Fleming, managing director in the private company services group of PricewaterhouseCoopers, to whom I turned for more answers.

Reader Carl Goldstein of Silver Spring said that "year after year I find myself arguing with one of my 401(k) custodians. They insist I cannot withdraw a penny more than I'm entitled to under the IRS formula." But you can, unless your 401(k) has special rules against it. When it comes to IRAs, you can take your required minimum distribution for the year from one retirement account or as many as you want -- as long you withdraw the correct total.

"The custodians know the rule that you have to take it out, but they don't necessarily know that it can be from any one IRA," Fleming said.

One question from several readers was when to take the distributions. Do you have to take the money all at once or can you break it up into multiple payments during the year? According to Fleming, it's up to you. "You can take it monthly or quarterly or once a year, depending on the IRA custodian's willingness and ability" to distribute the payments, he said. He recommends that clients take their annual withdrawals in the summer, at the same time each year. If you wait till late in the year to request the money, you might run into processing issues and delays that could result in a missed deadline, he said.

One reader was confused by the fact that his statements from his mutual funds break down his gains into long-term and short-term capital gains, thinking that meant that they should be taxed as such. But when the funds are withdrawn from a retirement account, they are not. Everything you take out is taxed as ordinary income. That's the deal you struck with the IRS when you saved that money on a tax-deferred basis.

There were questions too about what happens to the IRA if you die with a balance and it goes to heirs. Fleming said that's one of the biggest issues that PricewaterhouseCoopers encounters with its clients.

First of all, you need to name an individual as the beneficiary of your retirement account. Then make sure your beneficiary and your executor know about it, so the money doesn't get taken out in one lump sum by mistake. "Sometimes the executor calls the custodian and says, 'Pull out all the money,' and the custodian sends the check, and, boom, you're done," he said. Your heirs won't be able to put that one back in the bottle, he said, even though your intent had been to leave the balance to an heir who could take it in phased withdrawals over his or her life expectancy, which means lower taxes.

Life's only certainties may be death and taxes, but at least with taxes on IRAs, you can reduce the sting.

Are you afraid you won't be able to retire because of the debt you've accumulated? If you're willing to talk about your situation on the record, we'll pose your problem to an expert. Send e-mail

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