# WITHDRAWING FROM YOUR IRA: A GUIDE TO THE BASIC DISTRIBUTION RULES

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2 TABLE 1. SUBSTANTIALLY EQUAL PERIODIC PAYMENTS: A COMPARISON OF CALCULATION METHODS For a \$500,000 account, 7% interest rate, owner is age 50 and first-year withdrawal is in Minimum Annuity Distribution Factor Amortization First Year Withdrawal Amount \$12,755 \$38,118 \$37,654 the balance of all her IRAs combined is \$100,000, then 6% (\$6,000 \$100,000) of her distribution that year would be tax exempt. If she takes \$10,000, then only \$9,400 is taxable. In the second year, the numerator in that same equation would be \$5,400 (\$6, ), and the denominator is the market value of her combined IRAs as of the beginning of the next year she takes a distribution. Roth IRA: The other type of IRA is the Roth IRA, which allows for tax-free growth over the life of the account. There is no tax deduction in the year of contribution, but the contributions and all earnings in the account are distributed tax free upon withdrawal. Another attractive feature of a Roth is that it escapes the required minimum distribution rules at age 70½ that are discussed below. With that basic background information regarding the types of IRAs, you can better understand the various distribution rules and tax consequences of the timing of distributions from IRAs. EARLY DISTRIBUTIONS Since IRAs are vehicles to encourage saving for retirement, penaltyfree regular distributions cannot start until after the account owner turns age 59½. Generally speaking, a withdrawal prior to age 59½ will be subject to the ordinary income tax and a 10% early distribution penalty. Certain exceptions that allow you to avoid the 10% penalty will be discussed later. All taxable distributions from traditional IRAs will be subject to ordinary income tax i.e., no capital gains rates are applicable on distribution. You might be able to use one of the following exceptions to avoid the 10% penalty: Distributions due to death; Distributions due to disability; Distributions in the form of a series of substantially equal periodic payments (discussed below); Distributions for qualified deductible medical expenses; Distributions for qualified higher education expenses; and Distributions for qualified firsttime homebuyer distributions, up to a lifetime maximum of \$10,000. AVOIDING THE PENALTY A substantially equal periodic payment plan is the distribution option that allows an account owner who is younger than 59½ to receive distributions from an IRA without the 10% early distribution penalty. The substantially equal periodic payment amount must be withdrawn each year for the greater of five years or until the account owner attains age 59½. For example, someone who begins a substantially equal periodic payment at age 50 would be required to take out the equal amounts each year for 9½ years. Someone who begins a at age 58 would be required to take out that amount for five full years, or until they attained age 63. It is also important to note that a distribution only avoids the 10% penalty; the distributions will still be subject to ordinary income tax. The substantially equal periodic payment is a financial calculation best determined by a financial adviser. There are three methods to calculate an allowable withdrawal amount minimum distribution, annuity and amortization. (The mechanics of these calculations appear in our October 2000 AAII Journal article, Early Plan Distributions: How to Avoid the 10% Penalty. ) The minimum distribution method takes into consideration the account owner s age, account balance, and life expectancy. The annuity and amortization methods also factor in a reasonable interest rate. Typically, a larger withdrawal amount results with the amortization and annuity methods. The dollar amount yielded by the formula is the amount the account owner may withdraw from the account without paying the 10% early distribution penalty. Table 1 shows the withdrawal amounts for the first year under the three substantially equal periodic payment methods. The amounts assume a \$500,000 account, 7% interest rate, that the account owner is age 50 and that the first withdrawal year is Once an account owner starts a, the amount withdrawn cannot be changed until the greater of five years or when the owner reaches age 59½. The dollar amount that comes out of the IRA must be the same each year (although under the minimum distribution method the amount varies based on the changing year-end account balance and owner s life expectancy each year). Let s say you start a substantially equal periodic payment at age 50, and the penalty-free dollar amount to be withdrawn is \$50,000 (based on either the amortization or annuity methods). In this example, you would be required to withdraw \$50,000 each year until age 59½. AAII Journal/August

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