Many tax moves regarding retirement benefits are dictated by age.
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How old are you? Many tax moves regarding retirement benefits are dictated by age. The "big years" are age 59½ (everybody knows that) and also, surprisingly, age 69½.
Here's a review of age-based tips, from young to old:
If you are under age 59½...
If you are under 59½, you must take care to avoid the 10% "extra income tax" (usually called the "penalty") that generally applies to retirement plan distributions received before that age. So keep the following tips in mind:
Avoid penalties with a Roth account: Make your annual IRA contributions to a Roth IRA if you are eligible. That way, if you need to take money out prior to age 59½, you can withdraw your own contributions tax- and penalty-free any time.
Use caution with Roth conversions: If you convert any traditional plan or IRA to a Roth IRA, remember that the amount converted will be subject to the 10% penalty if it is withdrawn within five years after the conversion and while you are still under age 59½ (unless an exception applies). So treat that conversion account as "off limits" until that period has expired. Pay the income tax resulting from the conversion from some other source of funds, such as your outside money or Roth funds that were converted more than five years ago.
Message for widows/widowers: If you inherited a traditional retirement plan from your spouse, don't roll it over to your own IRA until you are over 59½. Leave it in your deceased spouse's plan and withdraw funds from it penalty-free if you need money. Death benefits are penalty-free, and as long as the money stays in your deceased spouse's plan, it is considered a death benefit when you withdraw it. Once you roll the money into your own IRA, it loses its penalty-exempt death benefit status. For one more age-based reason to leave money in a deceased spouse's plan, see the last tip in this article!
If you are a beneficiary: If you inherit any retirement plan, and find you need some cash, tap the inherited plan before you tap any of your own retirement plans. Not only are the withdrawals from the inherited plan penalty-free (as death benefits), they are subject to less favorable minimum distribution requirements than your own retirement plans. An inherited plan must be drawn down over your life expectancy, beginning the year after your benefactor's death. With your own plan, you can defer all distributions until you reach age 70½, then withdraw using the Uniform Lifetime Table, which provides a much slower withdrawal rate than the single life table applicable to inherited plans. So it is usually better to preserve your own plan and deplete the inherited plan, if you must deplete one or the other.
If you must tap your own IRA or plan: If you need or want to get money out of your own IRA or plan while you are still under age 59½, scour the multiple exceptions (there are at least 13) to see if any of them would shelter at least some of your withdrawal. For example, certain educational expenses occurring during the year can be matched with an IRA withdrawal the same year. Also, "aftertax" money withdrawn from a traditional IRA or plan is penalty-free.
If you are over 55 but still under age 59½...
If you separate from service in the year you reach age 55 or any later year, you can receive a distribution from your former employer's qualified plan without being subject to the 10% penalty normally applicable to "early distributions." So it makes sense (if you retire, quit, or get fired in your age-55 year or later) to leave your benefits in that company's plan until you need to cash them out, or until you are sure you will not need to cash them out, or you reach age 59½, whichever comes first.
If you are a fireman, policeman, or emergency medical personnel, make that "the year you reach age 50" rather than age 55.
--If you quit/retire/get fired earlier than the year in which you turn age 55 (or 50, whichever is applicable), you can't just wait until you reach that age and then access the money penalty-free. This "early retirement" exception only applies to separations from service that occur at the applicable age or later. Also:
--This exception does not apply to IRA distributions. It applies only to benefits under the retirement plan of the employer from whose service you have separated. That's why rolling the funds over to an IRA before age 59½ may be a mistake.
If you are older than 59½...
If you are older than age 59½, you can receive a distribution from any IRA or other retirement plan without being subject to the 10% penalty normally applicable to "early distributions," with one exception: If the distribution is part of a series of substantially equal periodic payments ("SOSEPP"), and is made less than five years after the first payment in the series, it will be subject to the penalty (unless some other exception applies).
The year you reach age 69½...
The year you turn age 69½ is a major "last chance" for certain planning opportunities. It is the last year in which you can convert funds from a traditional IRA to a Roth IRA without having to first take a minimum required distribution for the conversion year. If you are retired, it is also the last year you can roll over funds from your former employer's plan to your IRA without first having to take a minimum required distribution for the rollover year.
The year you reach age 70½...
The year you turn age 70½ is the first "Distribution Year" (year for which a minimum distribution is required under § 401(a)(9)) for your traditional IRAs and for all of your other retirement plans except:
--Roth IRAs, which have no minimum required distributions during the owner's lifetime; and
--Qualified retirement plans (including 403(b) plans) sponsored by employers of which you are not a "5% owner," if you have not retired by the end of such year. For these plans, your first Distribution Year is the year in which you retire or the year you reach age 70½, whichever is later.
The year you reach age 71½...
April 1 of this year is the "Required Beginning Date" for your traditional IRAs. That is the deadline for taking the minimum required distribution for your first Distribution Year (i.e., the year you reached age 70½). Dec. 31 of this year is the deadline for taking the minimum required distribution for your second Distribution Year (the year you reach age 71½).
If you are age 76 or older...
If you were born before Jan. 2, 1936, you may be eligible for "special averaging treatment" for a lump sum distribution you receive from a qualified retirement plan.
If you are an older surviving spouse...
Final age-based tip for today: Usually a surviving spouse is best advised to roll over, to his/her own IRA, any retirement benefits inherited from the deceased spouse as soon as possible. There are two age-based exceptions to this rule. One is if the surviving spouse is younger than age 59½, as discussed above.
The other is if the younger spouse dies first and dies before the year he or she would have reached age 69½. In this case, the surviving spouse can get the most deferral of required distributions from a traditional (non-Roth) retirement plan inherited from the deceased spouse by leaving the benefits in the deceased spouse's plan until the year the deceased spouse would have reached age 69½, then rolling them over (in that year) to the surviving spouse's own plan. This is easiest to explain with an example:
Consider Harry and Betty: Harry dies in 2012, leaving his IRA to his wife Betty, who is seven years older. Betty will turn age 69½ in 2012. Had he lived, Harry would not have turned age 69½ until 2019. If Betty rolls over the IRA into her own IRA in 2012, the benefits become part of "her" IRA for minimum distribution purposes, and she will have to start taking minimum required distributions (based on the Uniform Lifetime Table) in 2013, the year she will reach age 70½. But because she holds Harry's IRA as surviving spouse/sole beneficiary, she does not have to take any distributions from it until the year Harry would have reached age 70½ (2020). So she can enjoy 100% deferral by holding the account as beneficiary through the year 2019.
Once she becomes subject to taking required distributions, however, she is better off holding the account as owner rather than as beneficiary. That's because an owner takes distributions using the Uniform Lifetime Table, which gives much longer deferral (smaller required distributions) than the single life table applicable to beneficiaries. To avoid being forced to take any distributions as beneficiary, she needs to roll over the account no later than 2019, the year Harry would have reached age 69½. Then she can start taking distributions as owner in 2020, the year she will reach age 77½.
Resources: For detail on the 10% "premature distributions" penalty and its exceptions, see Chapter 9 of the author's book Life and Death Planning for Retirement Benefits (7th ed. 2011; www.ataxplan.com) or IRS Publication 590. Regarding the "SOSEPP," death benefit, and early retirement exceptions to the penalty, see respectively ¶ 9.2–¶ 9.3, ¶ 9.4.01, and ¶ 9.4.04 of Life and Death Planning for Retirement Benefits.
For who is eligible to contribute to a Roth IRA, see ¶ 5.3.02 of Life and Death Planning for Retirement Benefits. Regarding Roth conversions prior to age 59½, see ¶ 5.5.02 of Life and Death Planning for Retirement Benefits.
For the minimum required distribution rules, including those applicable to individuals, surviving spouses, and nonspouse beneficiaries, see Chapter 1 of Life and Death Planning for Retirement Benefits. To compare the Uniform Lifetime Table and single life table, see IRS Publication 590 or Appendix A of Life and Death Planning for Retirement Benefits. For the effect of a rollover in the first Distribution Year, or any other year for which a minimum distribution is required, see ¶ 2.6.03 of Life and Death Planning for Retirement Benefits.
Regarding special averaging treatment for certain lump sum distributions paid on behalf of individuals born before 1936, see Instructions for IRS Form 4972 and the Natalie Choate Special Report: "Ancient History," downloadable free at www.ataxplan.com.
Regarding advice for a surviving spouse, see "Road Map: Advising the Surviving Spouse," at ¶ 3.1.02 of Life and Death Planning for Retirement Benefits.