Going Through Withdrawal
A fter years of putting money away for retirement, you’d think that tapping those savings would be the easy part. Think again.
It turns out that the rules covering withdrawals are complex, and your decisions about taking money out can have serious consequences. When and how much to withdraw from your retirement accounts are among the most frequent questions I’ve been asked since I started writing this column.
When I started looking into the issue, I knew the basics. In general, at age 59 1⁄2, you may take distributions from your IRA and 401(k) without the 10 percent penalty you would incur at an earlier age. If you take the money, you’ll be liable for taxes on the amounts withdrawn. By age 70 1⁄2, you no longer have a choice when it comes to traditional IRAs and, in most cases, 401(k) plans. You have to take some of the money.
But beyond that, I wasn’t sure. What’s the smartest way to time those withdrawals? And how much are you required to take out?
I talked to two experts, Olivia S. Mitchell, executive director of the Wharton School’s Pension Research Council, and Bill Fleming, managing director in the private company services group of PricewaterhouseCoopers. What I learned is how much there is to learn. I expect I’ll be writing more about this subject as we go along.
Let’s start with when you should start taking money out. Mitchell and Fleming said the timing hinges, among other things, on how withdrawals affect your tax liability. Depending on your income, you might be better off starting before you turn 70 1⁄ because if you wait, your
2 mandatory distribution might be larger — potentially leading to a bigger tax bill.
If you decide to wait until you reach 70 1⁄2, the law says, you have to make your first withdrawal by April 1 of the year after that magic half-birthday. However, your second annual withdrawal will have to be made by the end of that same year. That could require you to take two withdrawals in one year, increasing your taxable income and possibly putting you in a higher tax bracket.
“It gets very devilishly complicated because of the tax side of the story,” said Mitchell.
Another frequent question is whether you can take your withdrawal from a single account or need to spread it among all of them.
Suppose you have a traditional IRA (where your tax-deferred income has been growing), a Roth IRA (where money on which you have already been taxed has been growing) and a 401(k) plan with your former employer.
First of all, don’t worry about the Roth IRA. You don’t have to take any minimum withdrawals from there, even after age 70 1⁄2. The government has already collected taxes on contributions into that account, so money invested in your Roth can stay there, earning more without any future tax consequences.
What the IRS cares about is money on which taxes have been deferred. That’s why the government requires you to take distributions from both your traditional IRA and your 401(k) by a certain age. To simplify withdrawals, Fleming said he tells people who are older than 70 to fold their 401(k) accounts into traditional IRAs.
There is one exception regarding 401(k) withdrawals: You don’t have to take a distribution at age 70 1⁄ if you’re
2 still working for the company that sponsors the plan.
“I’ve been working in this area for 20 years, and I just found that out,” said Mitchell, testifying to the complexity of what economists often refer to as the “decumulation” phase of retirement planning.
As for how much you are required to withdraw, the answer depends on life-expectancy tables used by the IRS. Finding them, however, requires wading through some long IRS publications. The best place to go is a document called Publication 590, which has the tables cleanly laid out at the end. It can be found at http://www.irs.gov/pub/ irs-pdf/p590.pdf.
Of the three tables at the end of Publication 590, the one that matters to most IRA holders is Table III, or Uniform Life. (There is also Table II for folks with much younger spouses and Table I for IRA beneficiaries.)
According to the Uniform Life table, average life expectancy at age 70, also known as the “distribution period,” is 27.4 years. For example, if I had turned 70 1⁄ at the end of last year, I would need
2 to divide the total amount left in my tax-deferred retirement plan by 27.4 to know how much to take out this year.
Although you may take out more than your required mandatory minimum withdrawal, the calculations are designed to make the money last a lifetime, says Marty Pippins, the IRS’s manager of employee plans, technical guidance and quality assurance, who helped me find the tables.
And you need to keep checking those tables. That I have a life expectancy of 27.4 years at age 70 doesn’t mean I will continue to divide my balance by that number every year thereafter. The longer you live, the longer you can expect to live. At age 75, my life expectancy wouldn’t be 22.4 years (27.4 minus 5) but 22.9 years, and my required withdrawal would be what was left in my accounts divided by that number.
Could it be more complicated? Maybe. We haven’t even touched on issues such as what you should do with the distributions you take, assuming you don’t need them to live on.
“It’s a huge mess,” said Fleming. “Whole books have been written about IRAs and minimum distributions. Probably one of the most complicated calculations, and continuing calculations, is imposed on an aging group who is most likely to have a problem at some point.” Any questions about retirement that you’d like to see explored in the column? Please e-mail me at email@example.com.