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An IRA distribution describes a withdrawal of cash and/or assets from an IRA. Distributions can be taken at any time. The type of IRA will determine whether there are tax and penalties associated with distributions. Below are the two methods of distribution:
Cash Distributions - When an IRA holder requests a cash amount to be distributed from the account and sent via check, ACH or wire directly into their hands. This method of distribution can be used for the full distribution or
'In-kind' Distributions - Used to distribute non-cash assets from an IRA without selling these assets. This method of distribution changes the ownership of the asset from the IRA’s name to the name of the IRA holder. This type of withdrawal is used for illiquid assets like real estate and private placements. The Fair Market Value (FMV) of the asset is used to report to the IRS the dollar value of the distribution.
For both Cash and In-kind distributions, the IRS Form is used to report the distribution to the IRS and the IRA holder is the IRS Form 1099-R.
Once an IRA holder reaches age 72, it is required to withdraw a certain amount of money from the retirement account each year, depending on the type of IRA you have. That amount is called a Required Minimum Distribution, or RMD.
A Required Minimum Distribution (RMD) is the minimum amount that an IRA owner must withdraw yearly, starting with the year that he or she reaches age 72. Traditional IRAs, SEP IRAs, SIMPLE IRAs and Individual 401(k) plans are subject to this rule. Failure to take any portion of the minimum amount will incur a 50% penalty on the portion failed to be distributed. Keep in mind, the amount that must be withdrawn changes each year. The amount is based on a formula using the age of the individual for the year and the prior year-end account balance. Each retirement plan RMD must be calculated separately, however, if the account is an IRA, the amount can be distributed from other IRAs held by the account holder.
The typical deadline for taking RMDs is December 31 of each year. If it’s the first RMD, the distribution deadline can be extended until April 1 of the following year after they turn 72. If the first RMD is delayed, there will be two RMDs in that following year. It is important to know that taking more than the RMD will not reduce the amount of the following year’s RMD.
Important Tips:
Your RMD is generally determined by dividing the adjusted market value of your IRAs as of December 31 of the preceding year by a life expectancy number that corresponds with your age under the Uniform Lifetime Table [Table III in IRS Publication 590, Individual Retirement Arrangements (IRAs)]. The age used on the table is the age you would attain as of your birthday during the year. If your spouse is your sole beneficiary, and is more than 10 years younger than you, you have the option to use the Joint Life and Last Survivor Expectancy Table (Table II in IRS Publication 590) which will reduce the amount required. For Individual 401(k) plans, the Employer/Plan Sponsor is responsible for calculating and distributing the RMD from the plan. Failure to distribute the RMD for plan participants will jeopardize the plan’s qualified status which has tax consequences including plan disqualification.
Update from the SECURE Act of 2019: certain beneficiaries will no longer have the life expectancy option regarding inherited retirement plan accounts. Instead they will be required to distribute the inherited account in its entirety 10 years from the date of death of the IRA holder. Individuals who are exempt from this limitation are the IRA holder’s spouse, a disabled individual, a beneficiary less than 10 years younger, a chronically ill beneficiary, and a beneficiary who has not reached age of majority (minor). The minor beneficiary will revert to the 10-year option once they reach adulthood.
You can calculate your RMD with a few easy steps:
1. First, you must find your age that you would attain as of your birthday for the year. This age will have a corresponding distribution period or 'Life Expectancy Factor' on the table.
2. Your IRA balance as of December 31 of the previous year is then divided by your Life Expectancy Factor to calculate your RMD.
IRA holders will be subject to a 50% penalty for any amount failed to be distributed.
Example: As an example, if your RMD is $500.00 and you only distributed $400.00, you will have a penalty of $50.00.
Certain investments that are hard to liquidate may be an issue when it comes to taking a RMD. Although taking an in-kind distribution of a property may be an option to satisfy the RMD, it may be difficult and sometimes costly due to the costs involved in valuing the investment as part of the distribution process.
Option 1: Paying the 50% penalty, which many people don't think of. By paying the 50% penalty using the IRS Form 5329 and completing Section 9, the RMD does not have to be distributed for the year.
Keep in mind that distributions are subject to tax. The tax owed may not quite be 50% but will still cost the individual taking into account the federal and state tax on the distribution. Not taking the distribution also keeps the investment intact.
Option 2: Convert assets from their Traditional, SEP and SIMPLE IRAs to a Roth IRA. Roth IRAs are not subject to RMDs for the Roth IRA holder. Any RMD must be satisfied before converting any remaining assets.
(Includes Traditional, SEP, and SIMPLE IRAs)
The contributions you make to your IRA are intended to supplement your income during your retirement years. However, as much as you would like to let your IRAs remain untouched until retirement, unforeseen expenses may force you to distribute some of those assets prematurely. Should you decide to take a distribution from your IRA, these amounts may be subject to federal and state taxes.
If you take a distribution, you may be assessed an additional 10% early-distribution penalty on any taxable amount. The IRS imposes this penalty to deter individuals from taking premature distributions from their retirement accounts. The penalty may be waived for the following exceptions:
| Health Insurance |
If you are unemployed for a period of consecutive 12 weeks, you may take penalty-free distributions from your IRA to pay for your health insurance (COBRA).
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| Medical Expenses |
IRA distributions to pay for medical expenses that exceed 7.5 percent of their adjusted gross income.
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First-Time Home Purchase |
Distributions from an IRA of up to $10,000 to use towards the purchase of a home that qualifies as a first time home buyer. The IRS sees your home as a first-time home if you have not owned a home for the past two years. This $10,000 is a lifetime limit.
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| Death or Disability |
Upon death or if a physician determines that, because of a mental or physical disability, you are unable to engage in any gainful employment, you are allowed to take penalty-free distributions from your IRA.
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| Higher Level Education Expenses |
Any distributions that go towards any higher level education expenses for you, your child, your grandchild or your spouse's grandchild. There is no dollar limit for this exception. |
| Inherited IRA Assets |
If you are the beneficiary of a deceased IRA holder, amounts distributed from the Inherited IRA are not subjected to early-distribution penalty. Distributions taken the year after the death of the IRA holder are calculated based on the life expectancy of the beneficiary. |
| Periodic Payments |
Arranging a stream of annual distributions under one of three IRS - pre-approved methods – must be taken until the IRA holder is either age 59½ or for five years, whichever comes later. This is referred to as taking substantially equal periodic payments (SEPPs) from your IRA.
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| IRS Levy |
The 10% penalty is waived for amounts withdrawn from your IRA as a result of an IRS levy. However, if you voluntarily withdraw the amount from your IRA to pay the taxes owed without an IRS levy, the distribution will be subject to an IRA penalty.
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| Rollovers |
Distributions from 401(k) plans and IRAs are exempt from the early withdrawal penalty if rolled over into another eligible retirement plan within 60 days. Rollovers of distributions from IRA are limited to one in a twelve-month period for Traditional, Roth, SEP and SIMPLE IRAs combined.
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| Military |
Qualified reservist distributions are not subject to the 10% penalty. Distributions may be repaid back to a retirement plan within 2 years from distribution. |
| Qualified Birth or Adoption |
The SECURE Act of 2019 provides penalty-free withdrawals from retirement plans for any “birth or adoption distributions.” A couple can distribute up to $5,000 each (total of $10,000) from their retirement plans for birth or adoption expenses. The child’s name and tax identification number must appear on the individual’s tax return within 1 year of the birth or finalized adoption. |
Once you reach age 59½, you can withdraw funds from your Traditional IRA without restrictions or penalties. But keep in mind that your deductible contributions and earnings (including dividends, interest, and capital gains) will be taxed as ordinary income.
Beginning in the year you turn 72, you must start taking an annual Required Minimum Distribution (RMD) from your Traditional IRA. If you don’t make withdrawals, you’ll have to pay a 50% penalty on the amount you should have withdrawn. However, individuals who turned age 70 ½ in 2019 will still need to take their first RMD by April 1, 2020.
For the most part, Roth IRA withdrawal rules are more flexible than those for a 401(k) or even a Traditional IRA. Because you already paid taxes on the money you’ve contributed to a Roth IRA, you can withdraw your contributions any time, without tax and penalty. The keyword here is contributions — the money you put into the account. Different rules apply to conversion amounts and investment earnings.
If you are under the age of 59 ½, amounts converted must satisfy a 5-year period to avoid being subject to the 10% penalty.
To distribute investment earnings without owing income taxes and a 10% penalty, you’ll have to meet specific criteria. You must meet one of the following reasons: attaining age 59 ½, death, disability or first-time home buyer (maximum $10,000) as well as you must have satisfied the 5-year period. The 5-year period means its been 5 years since you have contributed to your first Roth IRA. The clock for the 5-year period begins as of January 1st of the year for which a contribution was made. As an example if you make a contribution on July of a calendar year, the clock started as of January 1st of that year.
Generally, you’ll owe income taxes and a 10% penalty if you withdraw earnings from your account. You can avoid the penalty, but not the income taxes, if you meet one of the following exceptions:
You can avoid taxes and penalties on earnings you withdraw from your account if you meet one of the following exceptions:
You’ll owe income tax but no penalty on earnings that you withdraw.
You can withdraw earnings with no tax and penalty.
Social Security income is typically not taxed as long as the combined taxable income of an individual or a married couple is below a certain level. IRS publication 915 provides more information on how your social security benefit is taxed. You may benefit from seeking the guidance of a tax advisor if you have further questions.
Regardless of your age, you will need to declare the distribution on the IRS Form 1040 which is your personal tax return. Show the amount of the IRA withdrawal on the line that state IRA distributions. Since you took the withdrawal before you reached age 59½, unless you met one of the exceptions listed in Publication 590-B, you will need to pay an additional 10% tax on early distributions and report it on Form 1040 as an additional tax. You will need to complete and attach a Form 5329 to report any amount subject to the early distribution penalty or to state an exception to a penalty. Certain distributions from Roth IRAs are not taxable.
