Traditional IRA Rules: How to Calculate Required Minimum Distributions (RMD)

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ira distribution and taxesYou probably already know that for Traditional IRAs you cannot withdraw the funds from your account prior to reaching age of 59 ½ years old, without facing a stiff 10% additional tax penalty.

But after you reach that age, you can start pulling money out (and just pay standard taxes) or leave it alone for additional years.

However, there will come a time when you absolutely, positively must begin taking distributions/withdrawals. Let’s take a closer look at some of the traditional IRA distribution rules related to this area and how to calculate required minimum distributions.

Important IRA Distribution Age

As mentioned above, age 59 1/2 is an important IRA milestone. But once you turn 70 ½, no matter how much you have (or have not) already taken from your account, there is a minimum dollar amount that you will be required to start withdrawing every year from whatever the remaining balance may be. This is known as a required minimum distribution (RMD).

Your RMD will be calculated as though your Traditional IRA was converted into a lifetime annuity. What this simply means is that you MUST start taking a small percentage of money out of the IRA “annually”.

There’s a specific formula and calculation that you have to follow to determine exactly how much money you have to take out for the the current year. Your life expectancy plays a big role in the calculation. It’s all spelled out in IRS Publication 590.

For example, when you turn age 70, the current RMD chart shows that your life expectancy is 17 more years. This applies to both men and women.

You can actually see how the formula and calculation work by visiting this RMD calculator

Individual Retirement Account (IRA) Taxes

No matter when you choose to withdraw money from your IRA you will still need to pay taxes on the amount. Keep in mind that the contributions you make into your traditional IRA are done so on a tax-deferred basis. As a result, the taxes will need to be paid during the same year in which money is pulled out of the account.

In order to decide how much you will need to pay in taxes from the amount you have withdrawn, use the following steps as a guide. Of course, when in doubt, speak to a tax professional. Here are the steps:

1. Find out how much money you are required to withdraw. Use the RMD calculator mentioned above.

2. Determine whether you have made any contributions to your Traditional IRA that are considered to be nondeductible. Nondeductible contributions would consist of those that you couldn’t claim on your federal tax return for whatever reason. As such, you may have already paid taxes on that money years ago. If so, that will lessen your current tax burden.

But again, if you took a tax deduction when you made the contribution, then the amount is fully taxable.

3. Obtain a copy of IRS Form 8606, Nondeductible IRAs. It can be found at the following link, and can be printed out:  Complete this form in order to calculate the partial amount of tax that you will owe on your Traditional IRA withdrawals from contributions that were nondeductible. If you are uncertain as to how to complete this form, it is recommended that you speak with a tax expert.

4. Tally up the remaining portion of your distribution that is fully taxable. When in doubt, speak to a tax adviser.

So that’s it. Now you know how to calculate required minimum distributions for your IRA. There’s no doubt that it and some of the traditional IRA distribution rules can get tricky if your finances are complex. I would suggest using the above steps if your goal is to get a general idea of what you’re looking at as far as distribution amounts and taxes. But if there’s any uncertainty on your part when it comes time to prepare your tax return, consult a CPA or tax professional.