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TAX TIP No. 54
Deadline looms for mandatory IRA withdrawals

You can't take it with you, and that definitely pleases the Internal Revenue Service. But the tax collector doesn't want you to leave a lot of your money to heirs, either. This forces senior citizens to dip into their nest eggs each year or pay additional taxes.

In this tax tip:

When you turn 70½ you must begin taking money from your tax-deferred retirement accounts, such as a traditional IRA, workplace 401(k) or self-employed retirement plans.

It's no secret why the IRS wants you to start drawing down these accounts. Your money sat in the account for years, tantalizingly out of reach of the IRS as it accrued tax-deferred earnings.

The IRS has created tables to calculate these annual withdrawals, known as required minimum distributions or RMDs. They use longevity data and are designed to ensure that most of your retirement benefits are paid to you during your lifetime.

Although RMDs are triggered once you turn 70½ you get a bit of timing leeway for your first required withdrawal. You have until April 1 of the year that follows the calendar year of your 70½ birthday, which is six calendar months after your 70th birthday.

Special 2009 rules
And in 2009, some seniors still coping with the stock market decline get another RMD break. They don't have to take this year's required withdrawals.

RMD amounts generally are calculated by dividing a retirement account's balance by the life expectancy factor found in the IRS tables. The balance you must use is the account's value at the end of the year before you turn 70½. For retirees facing a 2009 withdrawal, that meant using account values that had taken hits during the recent stock market downturn. So a provision of the Worker, Retiree, and Employer Recovery Act of 2008, signed into law on Dec. 23, 2008, waives the 2009 RMD.

But be careful. The 2009 RMD waiver isn't absolute.

If you turned 70½ last year and delayed your first distribution until this April 1, you must still take that 2008 distribution this year. But at least with the 2009 RMD waived, you only have to take out the 2008 amount in 2009. You don't have to take your 2009 RMD by the end of the year.

There's one other way you could avoid taking out your retirement money and still avoid the hefty penalty that is usually assessed on missed RMDs. You can have your RMD amount transferred directly to an eligible charity.

Why withdraw?
You don't care what the rules are; you don't need the money; you don't want to pay taxes on any withdrawals; and you're leaving your account untouched. Not a good idea.

Failure to withdraw triggers an excess accumulation tax. This levy is 50 percent of the required distribution that you didn't take. For example, you didn't withdraw the required $1,000 from your traditional IRA. The tax charge for your defiance is $500. For a taxpayer in the 25-percent income tax bracket, that's twice what you would have paid in taxes if you'd simply followed the RMD rule.

If you can convince the IRS that your distribution shortfall was due to "reasonable error" and that you're taking steps to rectify the situation, the agency could waive the penalty. In that case, file Form 5329 (part VIII), go ahead and pay the excess accumulation tax and attach a letter of explanation. If the IRS agrees that you shouldn't be penalized, it will refund the excess tax.

Determining your distribution
OK, you've accepted that you must start siphoning off your retirement fund. Now, it's important to find out just how much money you have to withdraw.

The IRS has created three tables based on life expectancies to figure the minimum withdrawal amount, which is a percentage of your IRA based on your age.

Retirement-plan beneficiaries use the first table.

Married account owners with spouses more than 10 years younger use the second table. Because its calculations incorporate the younger age of the spouse to spread withdrawals over a longer life expectancy, these account owners don't have to take out as much.

-- Updated: March 23, 2009
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