Planning Retirement Withdrawals

Are you thinking of retiring soon, or changing jobs? You may face a major financial decision: what to do about the funds in your retirement plan. This article will discuss partial withdrawals and full withdrawals.

Note: As you will see, the rules on retirement withdrawals are quite complex. They are offered here only for your general understanding. Please call us before taking withdrawals or making other major changes in your retirement plan.

Take a Partial Withdrawal

Partial withdrawals are withdrawals that aren't rollovers, annuities, or lump sums. Because they are partial, the amount not withdrawn continues its tax shelter (see below).

A partial withdrawal will usually leave open the option for other types of withdrawal (annuity, lump sum, rollover) of the balance left in the plan.

Note: Before retirement, partial withdrawals are fairly common with profit-sharing plans, 401(k)s, and stock bonus plans. After retirement, they are fairly common in all types of plans (though least common with defined-benefit pension plans).

Tax Planning. A partial withdrawal is taxable (and can be subject to the penalty tax on withdrawals before age 59-1/2) except to the extent it consists of after-tax contributions, such as nondeductible IRA contributions.

Example: Your retirement account totals $100,000, which includes an after-tax investment of $10,000. You withdraw $5,000. $500 of the withdrawal is tax-free ($10,000 / $100,000 x $5,000).

Note: The tax-free portion is computed differently for plan participants who have been in the plan since 5/5/86. Contact us for details.

Preserving the Tax Shelter. Your funds grow sheltered from tax while they are in the retirement plan. This means that the longer you can prolong the distribution - or the smaller the amount you must withdraw - the more your assets grow. Some people choose to defer withdrawals for as long as the law allows to maximize assets and shelter them for the next generation.

Note: The law has specific rules about how fast the money must be taken out of the plan after your death. These rules limit the ability to prolong a tax shelter.

Withdrawal Before You Reach Age 70-1/2

Until you reach 70-1/2, you do not need to take money out of your retirement account - unless your employer's plan requires it. In fact, there will usually be a 10% early-withdrawal penalty if you make withdrawals before age 59 1/2. This is on top of the regular income tax you owe - at any age - on amounts you withdraw (though there's no tax on after-tax contributions you made, as we discussed above).

Once You Reach Age 70-1/2

Once you hit 70-1/2, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 70-1/2 - say April 1, 2011 if you reach 70-1/2 in 2010. But waiting until April 1 means you must withdraw for two years - 2010 and 2011 - in 2011. To avoid this income bunching and a possible higher marginal tax rate, we may suggest withdrawing in the year you reach 70-1/2. Call us to evaluate your situation.

The rules allow you to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules, the taxpayer (say, an IRA owner) first determines how much he's saved as of the end of the preceding year. Then he consults a (unisex) IRS table to find the number for his age. The number corresponds to how long he may spread out the withdrawals. The owner then divides that number into the retirement asset total. The result is the minimum amount he must withdraw for the year.

Example: Joe reaches age 70-1/2 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 70 is 27.4. Joe must withdraw $21,898 ($600,000/27.4) this year.

Example: Two years from now, Joe is 72 and his IRA was $602,000 at the end of the preceding year (when Joe reached age 71). The IRS number for age 72 is 25.6. Joe must withdraw $23,516 ($602,000/25.6) when he's 72.

The number in the IRS table assumes distribution over a period based on your life expectancy, plus that of a beneficiary 10 years younger than you. If your designated beneficiary is a spouse more than 10 years younger than you, his or her actual life expectancy is used to figure the withdrawal period during your lifetime.

Caution: You can always take out money faster than required - and pay tax on these withdrawals. However, the tax code is strict about minimum withdrawals. If you fail to take out what's required, a tax penalty will take 50% of what should have been withdrawn but wasn't.

Financial Calculator: Required Minimum Distribution
The IRS requires that you withdraw at least a minimum amount - known as a Required Minimum Distribution - from your retirement accounts annually, starting the year you turn age 70-1/2. Determining how much you are required to withdraw is an important issue in retirement planning.