IRS Tax Rules – Taxes and retirement accounts

Retirement accounts grow tax-deferred until you need the funds. However, in most cases your money cannot remain in these accounts forever. The IRS has rules that dictate when and how much you must withdraw from your retirement accounts.

IRS Rules About Retirement Accounts

  • Required withdrawals. The amount you must withdraw each year is called your required minimum distribution (RMD). You can withdraw more than the required minimum distribution from your retirement accounts, but if you fail to take at least the required minimum on time, you face a severe 50% penalty. These rules apply to traditional IRAs and qualified retirement plans, but they do not apply to Roth IRAs during the owner’s lifetime.In most cases, you must begin withdrawing money from your retirement accounts as follows:
    • Your first withdrawal can either be taken in the year you turn age 70½, or it can be postponed until April 1 of the following year.
    • Your second withdrawal must be taken by December 31 of the year after you turn 70½.
    • In each subsequent year, you must withdraw at least the required minimum amount by December 31.

    If you’re still working at age 70½ and you own less than 5% of the company you work for, you can wait until you retire to begin taking distributions from qualified plans, such as 401(k)s. This exception does not apply to traditional IRAs.

  • Income tax planning. Your retirement fund trustee must tell the IRS whether you are required to take a minimum distribution. Because all or part of your distribution may be taxable income, it is important to include RMDs in your tax planning.
  • Estate planning. Retirement accounts are subject to estate tax as well as income tax. If you die owning an IRA or 401(k), your plan will be considered an asset in your estate and, like every other asset, it could be subject to estate tax. And since most retirement plans contain untaxed income, your plan could also be hit with income tax when it is distributed to your heirs. Unless you want the tax man to end up with a large chunk of any retirement funds left in your estate, planning is essential.

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