In the United States, people can save money for their retirement years by making annual contributions into Individual Retirement Arrangements (IRAs). On most kinds of IRAs, the Internal Revenue Service (IRS) requires account holders who are 70½ or older to begin making mandatory annual withdrawals. Anyone who fails to make the IRA mandatory withdrawal incurs a federal tax penalty.
IRAs are generally funded with pre-tax earnings. Account holders designate their contributions as IRA money but can invest their contributions in a variety of different investment instruments, including stocks, bonds, and real estate. IRAs provide a tax shelter, which means that the account holder pays no taxes on contributions or earnings until withdrawals are made. The IRS imposes the IRA mandatory withdrawal rule in order to prevent taxpayers from shielding money from taxes for the entire duration of their lives.
Required minimum distributions from IRAs are based upon the account holder’s life expectancy or the joint life expectancies of the account holder and the account holder’s spouse. The IRS produces actuarial tables that account holders can use to determine the size of the IRA mandatory withdrawal that they must make. These tables are based upon statistical averages of life expectancy. Many people own multiple IRAs, in which case they must make a withdrawal that is based upon their combined IRA balances. An account holder can withdraw money from just one IRA rather than taking withdrawals from each IRA that they own, as long as the total amount withdrawn meets the minimum required by the IRS.
For the first withdrawal, an account holder can make the IRA mandatory withdrawal at any time between 1 January of the year in which they turn 70½ and 1 April of the following year. In subsequent years, withdrawals must be taken between 1 January and 31 December of the same calendar year. Therefore, an IRA account holder may make their first two annual withdrawals within the same calendar year. Anyone who fails to take the annual withdrawal must pay a penalty tax equal to 50 percent of the required minimum distribution that they failed to make.
Roth IRAs are a type of retirement account that is funded by after-tax earnings. The money deposited into a Roth IRA grows on a tax-sheltered basis in the same way that other IRAs grow, so the account holder’s earnings are not taxed on an annual basis. Under federal tax laws, people do not have to make mandatory IRA withdrawals from Roth IRAs. Additionally, the IRS does not assess taxes on Roth withdrawals or Roth earnings.