Hand opening glass Jar used for IRA fundMany Americans are saving for their retirement in an Individual Retirement Account, a type of account that allows individuals to save for their own retirement tax-deferred. The money deposited in an IRA is tax-deductible, and not subject to taxes as it grows, but is taxed upon withdrawal instead. Disbursement of the funds in an IRA is an important part of retirement planning and spending, and caregivers who participate in this process need to know the basics. IRAs come in several flavors, and each has different rules about when and how the money can and should be withdrawn. Penalties, deadlines, and exceptions are possible complications that can lose your loved one money, and in retirement, every penny counts!

An IRA (Individual Retirement Account) is an account that allows an individual to save for retirement by depositing a limited number tax-deductible dollars each year. This money grows tax-free, or tax-deferred, and is instead taxed upon withdrawal, or disbursement, at retirement age. The account is set up at a financial institution and the choice of account depends on both eligibility (403bs are for teachers, for example) and the way you prefer to pay the taxes. While there are several kinds of IRAs, the two main types are Traditional and Roth:

  • Traditional IRA: you contribute money that is usually deductible from your taxes – pre-tax dollars. Any earnings in the account potentially grow tax-deferred until you withdraw them in retirement. Since many retirees find themselves in a lower tax bracket post-retirement, deferring taxes on this money means they pay a lower rate than they would have at the time of deposit.
  • Roth IRA: you contribute money you’ve already paid taxes on – after-tax dollars. Once in the account, the money potentially grows tax-free, and withdrawals in retirement are not taxable – IF certain conditions are met.

So an IRA sounds like a great way to save and grow your money until retirement, but unfortunately the law limits the amount an individual can contribute each year, and after 70 ½ , you can’t contribute at all. And, you aren’t allowed to just sit on the money – you are literally forced to withdraw your money after you turn 70 ½. This is called a Required Minimum Distribution, or RMD, and while you can take more than the minimum, you can’t take less without serious penalty. Much like Goldilocks and her porridge, you can’t take your money too early, and you can’t take it too late – you have to take it at exactly the right time. But the IRS is terrible at writing fairy tales, so we’ll give it a shot.

Just as contributing money to the Traditional IRA and the Roth IRA differ, so does withdrawing money.

  • First, you can start taking money from your Traditional IRA at age 59 ½ without incurring a penalty for early withdrawal. You will have to pay taxes on whatever amount you take, though, at your current tax rate. Or, you can leave it in the IRA and let it keep growing for another 11 years.
  • At age 70 ½, though, you must begin to take the mandatory minimum amount (RMD) annually, or pay serious penalties. This amount is taxable at whatever your current tax rate may be, and the financial institution that holds the account will help you calculate the correct amount.
  • If you wait until age 70 ½, there’s a special timetable for taking the withdrawal:
    • You have until April 1 of the year after you turn 70 ½ to take the first RMD
    • All years after the first year, you have until December 31st.
    • If you delay your first distribution on April 1 of the year after you turn 70 ½, you will still have to take that year’s regular RMD by December 31, thus taking two in one year. Ouch.
  • Once you start taking RMD’s you take them every year until you die.
  • If you take less than the RMD, you will pay a penalty of up to 50% of the amount you don’t take.

How much is your RMD? For 2015, take your IRA account balance as of December 31, 2014 and divide it by a distribution period from the IRS’s “Uniform Lifetime Table.” Uniform Lifetime Table (PDF)  Or, use Fidelity’s MRD Calculator.

There is no Required Minimum Distribution requirement for a Roth IRA during the lifetime of the original owner, but the rules are different if you inherit a Roth IRA.

Just to make things really fun, inherited IRAs are subject to different disbursement rules, since beneficiaries are treated differently than the original owners of retirement accounts. Caregivers are equally as likely to be helping loved ones with IRAs inherited from spouses, siblings or parents as they are with personal retirement accounts. We will discuss Required Minimum Distributions for Inherited IRA’s in Caregiver Cheat Sheet Part II next month, but we can’t emphasize enough that there is no substitute for professional tax advice!