While individual retirement accounts (IRAs) may not have been around for all that long—they weren’t formally established in the US until 1974—they have quickly become one of the most popular retirement savings tools for Americans. According to the Employee Benefit Research Institute, there are nearly 26 million IRAs in existence, comprising a total of up to $2.46 trillion in assets.
It’s easy to understand why so many people choose to start a traditional IRA. Contributions are usually tax-deductible; growth in the account occurs on a tax-deferred basis (so you’re not taxed on the assets in your account until you withdraw them); and they are available to anyone under the age of 70½ with some form of income, which means that you can open and contribute to one even if you are self-employed or deposit income from a spouse.
However, despite the fact that starting and contributing to an IRA can be a fairly simple process, many people are less certain about how an IRA works after they retire. To learn more about how IRAs work in retirement, read on for a look at some frequently asked questions.
How and when can I access my IRA funds?
Although the main purpose of an IRA is to help you save for retirement, you still technically have the option to withdraw funds from the account at any time, even before you have retired. However, it’s important to be aware that if you take any distributions from your IRA before you reach the age of 59½, you’ll likely be charged a 10% early-withdrawal penalty (you’ll also have to pay income tax on the amount that you take out).
Equally important to know about are two of the main exceptions to the early withdrawal penalty rule. When distributions are used for one of a number of designated purposes—including health insurance, unreimbursed medical expenses, or a first home purchase—the IRS will waive the penalty. You also won’t have to pay a penalty on any money withdrawn from your IRA if you replace the sum within 60 days, which can be helpful if you need some liquid funds to cover a short-term cash flow issue.
Once you’re over the age of 59½, no penalties are applied to any IRA distributions, although you will of course be subject to income tax on any amount that you withdraw.
What do I need to know about required minimum distributions?
After you turn 59½, you can begin taking distributions from your IRA, but you don’t have to do so, even if you’re already retired. That requirement doesn’t happen until you turn 70½. At this age, it’s mandatory to start withdrawing a certain amount, known as the required minimum distribution (RMD), from a traditional IRA.
Typically, RMDs must be taken by December 31 each year. The only exception to this is your first RMD, which you are allowed to defer until April 1 of the year after you turn 70½. For example, if you turned 70½ in August 2019, you can choose not to take your first RMD until April 1, 2020. However, if you opt to delay, remember that you’ll need to take two RMDs in 2020 (the first by April 1 and the next by December 31), which could affect your income taxes.
Finally, it’s important to understand that a failure to take required minimum distributions from your IRA once you’re over the age of 70½ can have serious consequences. Unless the failure to take the RMD was due to a reasonable error, which you’ll need to convince the IRS of, you’ll be required to pay a penalty of 50% of the missed distribution.
What are some helpful IRA withdrawal strategies?
When it comes to RMDs, remember that even though you’re required to withdraw the money, you’re not required to spend it. This can be helpful to keep in mind if you’re still working past the age of 70½, for example, or if you have sufficient funds from other sources so that you don’t need to tap into your IRA just yet.
So what can you do to keep your required IRA distributions working for you? Some options include reinvesting the distribution (that is, purchasing stocks, bonds, or mutual funds), or purchasing an annuity to give yourself a stream of guaranteed income payments for life (a tax professional can help you to choose an appropriate annuity that is eligible to be funded by RMDs).
You could also consider converting the assets in your traditional IRA to a Roth IRA, which is a specific type of IRA that is funded with after-tax dollars. While this means that you will probably pay a significant amount of income tax in the year that you convert a traditional IRA to a Roth IRA, it also means that future withdrawals from a Roth IRA are tax-free, which can be a major advantage if you want to leave the assets to your heirs as a legacy. In addition, Roth IRAs do not have RMDs, so you can leave your assets in place as long as you’d like.