Required minimum IRA distributions are back this year, after a break from Congress in 2009 that was intended to give accounts some time to bounce back from the lows of the recession. If you're out of practice -- or making a required distribution from your IRA for the first time -- here's what you need to know:
How It Works
Most people aged 70 1/2 or more have to take their distributions by Dec. 31, 2010, with one exception: If you turned 70 1/2 this year (2010), you can wait until April 1, 2011, says Rebecca Pavese, a CPA and the manager of Palisades Hudson Financial Group's tax practice in Atlanta. Just know that if you decide to wait until next year -- say you take it in March -- you'll have to take another by the end of the year, so two total.
How Much Do You Take?
Distributions are calculated by IRS rules, so you have to adhere to an exact formula. "The custodians are very good about issuing you a letter telling you about your required minimum distribution, or you can look at your December statement from the previous year, and calculate it using the IRS's tables," explains Pavese. Your 2010 distribution is based on your account's value on Dec. 31, 2009 and one of three IRS tables (found in Appendix C of IRS Publication 590 -- essentially, you're dividing your IRA account balance by what the IRS has determined is your life expectancy factor).
You want to make sure you're using the right table -- the first is for account beneficiaries, the second is for account owners whose spouse is more than 10 years younger than they are and is the sole beneficiary, and the third is for account owners whose spouse isn't the beneficiary or is less than 10 years younger than they are.
This money is taxed as ordinary income because you received a tax deduction when you contributed it. In most cases, Pavese says that if you had a bad income year this year -- say you were self-employed and lost money -- you should take a little extra because you have that negative income to offset the distribution. For example, if your required minimum distribution is $50,000, and you had a loss in income of $100,00, you could take an additional $50,000 out this year and save on taxes. Although you'll lose the tax-deferred status on the money, you can reinvest it -- in the same or similar vehicles -- in a taxable account so it keeps growing until you really need it.
The same strategy applies if you think your tax rate is going to go up next year and you're going to need more than the required minimum distribution then. Pull out that extra amount now, when you know what your tax rates are, and avoid an increase later. "Say you're planning a home renovation in 2011 and you're going to use money from your IRA, and you're exceeding the required minimum distribution amount. That's an example where you would want to take it in 2010 rather than 2011, assuming tax rates are going to go up, because you're going to take it anyway," advises Pavese.
Note that this veers from the standard advice, which is generally to defer income as long as possible. That's true when tax rates are going to be the same year to year, but if they might go up the following year -- which is the situation we're in now -- you're better off erring on the side of caution. To be on the safe side, wait to take your 2010 distribution until December, when we'll have a better idea of next year's tax rates.