retirement

Tapping Your IRA in Retirement

You can cash in your IRA all at once, but doing so could subject you to an enormous tax bill. You'll probably do better tax-wise by taking out as little as necessary each year.

Deductible IRAs

With a traditional IRA, once you reach age 59½, the threat of the 10% penalty disappears. You can withdraw as much from your regular IRAs as you want, penalty-free. Cash coming out of the account is taxable in your top tax bracket, except to the extent that it represents a return of nondeductible contributions.

You can cash in your IRA all at once, but doing so could subject you to an enormous tax bill. You'll probably do better tax-wise by taking out as little as necessary each year.

Not only does that hold down the tax bill you owe each year, but it also leaves more money in the tax shelter to enjoy continued tax-deferred growth.

But this tax shelter does not last forever.

Regular IRAs were created to help you accumulate money for your retirement -- not build up a pile of money for your heirs to inherit.

So, the law demands that you begin pulling money out when you reach age 70½. The minimum withdrawal schedule is designed to get all your money out -- and taxed -- by the time you die, or at least by the time your designated IRA beneficiary dies.

If you don't take out the minimum required each year, the IRS will claim 50% of the amount you fail to withdraw. (Calculate your minimum required distribution.)

Roth IRAs

Things are a lot easier with Roth IRAs, thank goodness. Once you reach age 59½ and the account has been opened for at least five years, you can take as much or as little from your account as you need -- all tax- and penalty-free.

You don't have to worry about a minimum distribution schedule, either. You never have to take a dime out of your Roth IRA. Unlike regular IRAs, a Roth IRA can be used to build up a stash of cash to leave to your heirs.

Passing your IRAs on

What if the IRA owner dies while there's still money in the tax shelter?

There's no early withdrawal penalty for your beneficiary, regardless of your age when you die or the beneficiary's age when he or she withdraws the money.

With traditional IRAs, withdrawals are taxable to the beneficiary (except to the extent that it represents nondeductible contributions) in his or her top tax bracket. That could create a substantial tax bill if the IRA is cashed in all at once.

The heir may be better off leaving the money in the IRA to continue taking advantage of the tax shelter. Of course, the IRS has something to say about that. The rules are complicated and set a minimum pace at which the money must be withdrawn and taxes paid.

With Roth IRAs, the money goes to your beneficiary tax-free. However, there is a minimum withdrawal schedule for heirs -- but again, withdrawals are tax-free.

A special surviving spouse rule also applies to both types of accounts. If the widow or widower is the beneficiary, he or she can claim the account as his or her own. If it's a traditional IRA, no withdrawals would be required until the new owner is 70½; if it's a Roth, the spouse would never have to tap the account.

Most Popular

House Approves $3,000 Child Tax Credit for 2021
Coronavirus and Your Money

House Approves $3,000 Child Tax Credit for 2021

The proposal would temporarily increase the child tax credit to $3,000 or $3,600 per child for most families and have 50% of it paid in advance by the…
February 27, 2021
Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?
Coronavirus and Your Money

Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?

The House passed President Biden's $1.9 trillion stimulus package. While the bill faces hurdles in the Senate, the provisions authorizing another roun…
February 27, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
Tax Tip: Reporting a 2020 RMD From an IRA That You Later Returned
Coronavirus and Your Money

Tax Tip: Reporting a 2020 RMD From an IRA That You Later Returned

If you paid back a "required minimum distribution" from an IRA last year, you still have to report the payout on your 2020 tax return.
February 23, 2021
How 10 Types of Retirement Income Get Taxed
retirement

How 10 Types of Retirement Income Get Taxed

When you're planning for retirement, it's fun to contemplate all the travel and rounds of golf ahead of you, but don’t forget about taxes.
February 9, 2021
Tax Changes and Key Amounts for the 2020 Tax Year
tax law

Tax Changes and Key Amounts for the 2020 Tax Year

There were a lot of tax changes for the 2020 tax year. Get familiar with them now – before you file your 2020 tax return.
February 8, 2021