Most of us are taught to start planning for retirement as soon as we have a “real” job. For many people, retirement planning includes saving money in a retirement account, such as an IRA or a 401(k) account. While saving money in a retirement account is certainly an important part of planning for a financially secure retirement, you also need to know the rules relating to the distribution of the funds held in the account. Toward that end, the Grand Forks retirement planning attorneys at German Law explain some important retirement plan distribution rules.
IRS Retirement Plan Distribution Rules
When and how you take distributions from a retirement plan can directly impact how that money is taxed by the IRS. Therefore, knowing some basic retirement plan distribution rules is essential. According to the IRS, the following general rules apply:
- Required distributions. Unless you elect otherwise, benefits under a qualified plan must begin within 60 days after the close of the latest plan year in which you:
- turn 65 (or the plan’s normal retirement age, if earlier) OR
- complete 10 years of plan participation OR
- terminate service with the employer.
- Distributable events. The law permits a plan to distribute an account after certain events (distributable events). Different distributable events apply to different types of plans, and different types of contributions or accounts within those plans. The plan is not required to allow distributions for every possible distributable event; however, the plan document must clearly state when a distribution will be made.
How to Plan for Retirement Distributions
Unfortunately, a single, sure-fire formula for deciding when to begin distributions and how much to withdraw does not exist. Without knowing exactly how long you will live and what your cost of living will be throughout your retirement years, it is impossible to devise a foolproof distribution plan. There are, however, some common strategies that are used when it comes to planning for retirement plan distributions, including:
- The 4 percent rule. The 4 percent rule holds that withdrawing 4 percent from a retirement fund in the first year, followed by inflation-adjusted withdrawals every year after, should ensure money is available to sustain a 30-year retirement. While this can be a useful general rule, factors such as your life expectancy, current financial market, and your standard of living should be considered as well.
- Fixed percentage. The 4 percent rule is adjusted each year for inflation, meaning you will not always take out 4 percent. Another option is to take out a fixed percent each year that is not adjusted for inflation. The downside is that if the market isn’t doing well, you could be taking out more than you should.
- Fixed dollar. As the name implies, this involves taking out a specific amount each month or year. It can make budgeting easier but can also be problematic if the fund isn’t performing well.
- Income only. Taking distributions of dividends and gains only allows you to leave the principal intact, providing a financial safety net. This only works, however, if the principal earns enough for you to live on the income alone.
- Minimize mandatory distributions. Traditional 401(k) accounts and IRAs have required minimum distributions (RMDs) that can increase your taxable income. RMDs must begin at age 72 and failure to withdraw the designated amount could result in a hefty tax penalty. Converting these accounts to a Roth account can reduce or eliminate RMDs.
Contact Grand Forks Retirement Planning Attorneys
Please join us for an upcoming FREE seminar. If you have additional questions or concerns about retirement planning distributions, contact the Grand Forks retirement planning attorneys at German Law by calling 701-738-0060 to schedule an appointment.