If you're like most people, you spend the majority of your professional life planning for your eventual retirement. This often means that you put money into an employer-sponsored IRA or some other type of retirement account each and every time you get paid until you're finally old enough to retire and start drawing on that money. What you might not fully realize is that some of these investments for your retirement are better for you than others, at least from a purely financial standpoint. That's largely because some of these investments are taxed differently than others. In addition, you can gain access to certain types of retirement accounts earlier than you can others without being penalized. When you're talking about IRAs, you'll learn quickly that there is something called a Required Minimum Distribution. If you're wondering why this matters, it's because it will have a dramatic impact on how much you pay in taxes with direct regard to the money in the account itself. That's why it's so important to take control of your own financial well-being and learn as much as you can about these types of things sooner rather than later. Fortunately, you’ve come to the right place to do exactly that.
Understanding Required Minimum Distribution
If you're trying to do your own taxes, the first thing that you're likely to realize about understanding Required Minimum Distribution is that like most other things where the Internal Revenue Service is concerned, it’s anything but easy to understand. As a matter of fact, it's enough to give most people a migraine. The first thing you have to realize is that people routinely talk about Required Minimum Distribution with regard to IRAs, but that's not the only time that the subject comes up. According to the IRS, the Required Minimum Distribution is an amount that an individual must withdraw from their retirement account on an annual basis once they reach the age of 72, provided that the individual in question has retired by that age. This is regardless of the type of retirement account that is in question. Things get a little bit more complicated because according to the IRS tax code, there is a different method that applies to IRAs with regard to Required Minimum Distribution. With other types of retirement accounts, there is a certain minimum amount that must be withdrawn on an annual basis or the individual in question faces tax penalties, but only if that person has actually retired and is no longer working. If they are still working, that money can continue to sit in the retirement account and accrue interest. With IRAs, there is a minimum amount that must be withdrawn every year from the age of 72 onward, even if the person is still working full-time. Otherwise, they will be penalized on their taxes every year until they start taking the minimum amount out of their account.
The Amount You Must Take Varies
Another thing that makes things more confusing is the fact that there isn't a standard amount that must be taken out on an annual basis across the board. Instead, the minimum amount that must be taken out of these accounts beginning at age 72 depends on the amount of money that the person in question has made, along with several other factors which will be discussed in this paragraph. For example, the IRS uses a calculator that basically divides the amount of money that the individual in question has made throughout their career and then divides that amount based on a predetermined life expectancy in order to get the minimum amount that must be withdrawn from the account on an annual basis. However, this only applies to individuals who are single. If you are married, your spouse's income also factors into the situation and that can change things considerably. In cases like that, the IRS has an entirely different calculator that must be followed. Therefore, the best way to ensure your financial well-being is to get familiar with the calculator that applies to your situation in order to know what to expect well before you ever reach the age of 72. That way, there are no unpleasant surprises.
Avoiding Tax Penalties
As previously mentioned, failure to take the minimum amount of money out of these accounts on an annual basis typically results in tax penalties and that can be extremely costly. As a matter of fact, there are certain situations where the tax penalty can be as much as 50% of the amount that you should have withdrawn for the year. Clearly, no one wants to get in this type of situation because it's basically like throwing your money out the window for no reason. If you do realize that you were late withdrawing money from an account or something has happened outside of your control which has caused you to be late, there are certain procedures that can be followed that require you to file special paperwork with the IRS which may prevent you from paying such steep penalties. However, the key is to stay on top of things, avoid withdrawing late and dealing with the situation promptly if something does require your attention so that one problem is not simply compounded on top of another.
It can be confusing to understand why you might face such tax penalties if you withdraw your money from a retirement account late, especially when the entire reason for setting up such an account in the first place is to have money for your retirement. It's also worth noting that not all employees have the ability to decide whether or not to have a retirement account, as some employers require it. There are different tax fees for all of these different types of accounts, so your first step is to know exactly what you are dealing with and then handle the situation accordingly once you reach the age of 72. Ideally, you'll know exactly how much you need to withdraw and by what date that money should be withdrawn in order to avoid penalties well before you reach retirement age so that any potential problems can be handled before they actually occur. That way, you have the potential to get as much money as possible for your retirement without spending the overwhelming majority of it in penalties.
Written by Allen Lee
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