An individual retirement account, also known as an individual retirement arrangement or IRA, is an account that holds investments intended to cover your expenses during retirement. IRAs are connected to the Internal Revenue Service (IRS) because the IRS must, at some point, address the tax issues related to the IRA funds. The IRS looks at IRA accounts in terms of life expectancy once you reach age 70 1/2, and this controls how much you can withdraw from the IRA each year thereafter.
Distribution Requirement Rationale
An individual retirement arrangement or account is designed to fund your needs through your retirement years. The IRS thus assigns penalties of 10 percent on the taxable portion of distributions you take early, with early being defined as prior to age 59 1/2 years of age. There are no penalties assessed for distributions taken between ages 59 1/2 and 70 1/2. After you reach age 70 1/2, however, the IRS assumes that you are running out of time to use your money. They require you to take minimum distributions every year based on life expectancy at that point because they want you to use the money in the IRA for its intended purpose.
How the IRS Calculates Distributions
The IRS uses life expectancy charts, along with the total value of your IRA, to determine your minimum distribution amount. Specifically, they take the value of the account and divide it by the number of estimated remaining years of life indicated on the chart. From the practical standpoint, this means that your required minimum distribution changes every year. Generally, the amount of the required minimum distribution gradually will decrease as you use up the funds in the IRA. For example, suppose you had $20,000 in your IRA. If you took a distribution at 75, based on the 2011 Uniform Distribution chart, the IRS assumes you will live for another 22.9 years. You thus would divide $20,000 by 22.9 to get about $873. This would leave $19,127 in the account. Because you cannot contribute to an IRA once you reach age 70 1/2, the next year, when your life expectancy is 22 years, your minimum distribution would be $19,127 divided by 22, or $869.
The Three Charts
The IRS does not use the same life expectancy chart for all IRA cases. Most people use the Uniform Distribution table. This is the table for people who own IRS without beneficiaries. If you have named your spouse as a sole beneficiary to your IRA and your spouse is at least 10 years younger than you, then the IRS uses the Joint Life Expectancy table. If you have named a beneficiary who is not your spouse, then the IRS uses the Single Life Expectancy table.
Depending on the type of IRA you've selected, the IRS may consider any withdrawals you make taxable income. If this is the case with your IRA, then it may be to your benefit to withdraw only the minimum distribution required according to the IRS charts. This allows the majority of your funds to remain in the IRA tax-deferred and gaining interest. On the other hand, the IRS assesses a penalty if you don't take out the minimum. The penalty at the time of publication was 50 percent on the difference between the required minimum and the amount you withdraw. For example, if you were supposed to take out $1,000 and took out $500, the penalty would be half of the remaining $500, or $250.
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