Tax Tips
Time for an IRA Distribution?
The law requires you to begin taking money out of traditional IRAs or face a penalty. But a new temporary provision allows you to direct your IRA distributions to a charity tax-free.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
December 15, 2006
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For taxpayers older than 70, one of the best ways to save money on taxes is to avoid one of the steepest penalties that Uncle Sam has in his arsenal: a 50% penalty if you fail to take your required annual distribution from your IRA by December 31. And don't think Uncle Sam won't find out if you don't. IRA sponsors are now required to give the IRS a heads up on who is supposed to be withdrawing money from their accounts.
The good news is you can direct some or all of this year's distribution to a charity and avoid the income tax you normally would have paid on that amount.
The law requires you to begin withdrawals once you reach age 70½, but the first withdrawal can be postponed to as late as April 1 of the following year. So if your 70th birthday was between January 1 and June 30 of this year, you turned 70½ in 2006. However, you can put off your first mandatory withdrawal until April 1, 2007.
The penalty we're talking about threatens folks who turned 70½ in 2005 or earlier. They are required to withdraw a certain amount -- based on the balance of the account at the end of the previous year and on their life expectancy. The required minimum must be paid out by December 31. Mandatory withdrawal rules do not apply to Roth IRAs (unless you inherited the account).
Failing to take the required distribution unleashes that stiff 50% penalty. If you are not certain that you have taken yours for 2006, call your IRA sponsor. If you must make a withdrawal, you can arrange to have income taxes withheld from the distribution to cover the tax bill you'll owe. You'll pay tax at your regular income tax rate, not the preferential capital gains rate that applies to other investments.
However, a new rule in effect for 2006 and 2007 allows IRA owners who are 70½ or older to make tax-free distributions of up to $100,000 a year when the money is sent directly from an IRA to a charity. Although you can't double dip and claim a charitable deduction, the tax break may be even more valuable because you won't have to include your IRA distributions in your adjusted gross income. As a result, you could benefit from other tax breaks, such as reducing taxes on your Social Security benefits or boosting your deductible medical expenses, both tied to your adjusted gross income.