By Patrick Duffy
I will soon have to begin taking minimum distributions from my IRAs. I have spoken to people at the institution where my accounts are. However, I am confused by what they are telling me. Can you help?
Distributions from IRAs is one of the most confusing aspects of personal finance. So, do not be too hard on yourself. More than you find it confusing
Of all the numbers in the Internal Revenue Code, 70 1/2, the age at which you must begin taking minimum distributions from your IRAs, is probably one of the most important. Where the number 70 1/2 comes from is anybody’s guess. Things could be a lot simpler if the number was just 70 or 71. Be that as it may, we have to deal with the hand we are dealt. Why is it so important? Because when you reach that age, the IRS says you must begin taking minimum distributions from your IRAs by April 1 of the year following the year in which you reach 70 1/2.
You have supplied your date of birth to me, so let us start with that date.
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Date of birth: Nov. 23, 1928.
Therefore, you reached age 70 on Nov. 23, 1998 and you will reach 70 1/2 on May 23, 1999.
So the date April 1, 2000 is the magical date. That is the date by which you must begin taking minimum distributions.
But there is nothing to stop you taking more than the minimum distribution, even taking all the money out at any time.
How do you calculate what is the minimum you must take out?
Step 1: Calculate how much money you have in all your IRA accounts on Dec. 31, 1999. Let us assume you have $50,000 in all your accounts together.
Step 2: Designate a beneficiary/beneficiaries for your IRAs.
Step 3: You have to choose what is called a "method." There are several methods you can pick from but the most common is called Term Certain. Each method has advantages and disadvantages. You pick your method, then go to the life expectancy tables and see how long you/you and your beneficiary are expected to live. Let us assume the life expectancy is 20 years.
Step 4: Divide $50,000 by 20, which equals $2,500. That is the minimum you must take out. Remember there is nothing to stop you taking out $3,000, $5,678 or even $50,000.
Step 5: The Term Certain method is the simplest to use because each year you simply reduce the divisor by 1. So, when you want to find out your minimum distribution for the next year, you divide the IRA total by 19, then 18 the next year again etc.
It is very important to take out at least $2,500. If you take out less, for example $1,500, then there is a 50 percent penalty to be paid on the shortfall.
For example: You should have taken out $2,500
You only took out $1,500
50 percent penalty 500
And this is in addition to regular income tax at federal and state levels.
A common mistake to be avoided is the following: remember you have until April 1, 2000 to take out your first minimum distribution. Now what year is this first distribution for? Ah, 1999. But, and a very important but, is the fact you have taken it out in 2000. And remember that you must now take out your regular distribution for 2000. This means that if you are not careful, you will have taken two distributions in the same year, 2000. This can add to your tax bill for that year.
Second, if you do that it can also increase the amount of your social security that is taxable. And we do not want that to happen.
As I have said, IRA distribution is one of the most complex of all areas of personal finances. Talk further to your accountant, financial adviser, etc. It is not an area you want to make a mistake with.
Patrick J. Duffy, M.S., CFP, is a certified financial planner practicing in New York City. He specializes in business and personal financial planning with the overall aim of enhancing an individual or family’s quality of life. His office is at 767 Lexington Ave., New York, N.Y. 10021. He may be reached at (212) 755-7736.
If you have a question related to business of personal finance, mail or fax it to The Business Section, Irish Echo, 309 Fifth Ave., New York, N.Y. 10016; (212) 686-1756.