IRAs, Roths, and 401ks With Taxed and Untaxed Minimum Required Distributions – MRDs


IRA and Roth IRAs are two examples of government-regulated retirement savings plans – called qualified plans. Both are generally personal plans you set up at banking-type institutions that you can contribute to and withdraw from yourself. Other examples of qualified plans associated with work are 401(k), 403(b) and their Roth versions- like Roth 401(k).

This article explains which qualified plans have minimum required distributions (MRDs) associated with them and some strategy.

Qualified plans such as 401(k)s, and IRAs were created with specific tax characteristics as an incentive for people to save for their retirement by contributions from their working income.

There are fundamentally two different qualified plan type tax characteristics. I’ll call them

* Deductible Contributions then later taxed, and

* Nondeductible Contributions then never taxed

Taxation and Obligations for the owners (i.e. plan contributors) of the plans

The tax characteristics of the ‘deductible contributions’ type plans are represented by your 401(k) at work or your own IRA. Your yearly contributions to each plan are limited but deductible from your income in the year of contribution. But the income tax of both those contributions and all earnings they create are tax-deferred until you withdraw money from your plan.

Whenever you withdraw from these plans, the withdrawal amount in that year is added to your income to be taxed at your income tax rates. Since qualified plans are geared for retirement, you’re penalized with a tax of 10% on your distribution in addition to whatever income tax is incurred if you’re under 59 1/2.

Lastly, government-regulations obligate you to make at least a minimum required distribution (MRD) each year from your IRAs after you’ve turn 70 1/2.

The tax characteristics of the ‘non-deductible contributions’ type plans are represented by your Roth 401(k) at work, or your own Roth IRA. Your yearly contributions to these plans are limited, but they’re not deductible from your income for taxation. So they’re taxed. But the advantage now is that they and all their earnings and gains will grow each year tax-free – not just tax-deferred.

Additionally, when you withdraw from these Roth-type plans, the money comes out tax-free. But you must wait to withdraw your money until reach 59 1/2 or be penalized as above.

If you’re the owner of a personal Roth IRA, you have no obligation to make any MRDs ever. If you leave your Roth IRA to your spouse, she also has not obligation to make MRDs either.

If you have a Roth 401(k)s, you must make the normal RMDs as those with non-deductible contribution types above, but – like all Roth plans – the money comes out tax free.

What about plan beneficiaries after you die?

All beneficiaries of plans -401(k)s, IRAs, Roth 401(k)s or Roth IRAs – must make MRDs except the spouse beneficiary of a Roth IRA if she chooses to be owner. But remember, RMDs or withdrawals from Roth plans always come out tax free.

How much money must come out in an RMD?

The MRD for a specific year is the value of your IRA (or total of all your IRAs if you have more than one) as of Dec. 31 of the previous year, divided by your life expectancy factor (from IRA table found in Appendix C of IRS publication 590 (online)) for that specific year. So, each year your MRD will change since the value of your IRA will change and your life expectancy will change. A new calculation must be done each year.

You can withdraw more than your MRD, but you’re penalized if you withdraw less. You’re penalty is a tax equal to 50% of that part of your MRD you didn’t withdraw.

Reasons for converting to a Roth IRA Tax free growth and tax free withdrawals forever is hard to pass up. And that’s for owners, spouse beneficiaries and nonspouse beneficiaries.

Only the nonspouse beneficiaries need to make RMDs – but they’re still tax free ones. And those RMDs are based on the beneficiary life expectancy. So if their young, very little has to be taken out.

It makes good sense to convert any Roth 401(k) to your own Roth IRA for the freedom of not having to make RMDs by the owner or his spousal beneficiary. The conversion is tax free.

Conversion from a ‘deductible contributions’ plan to your Roth IRA requires you to pay income tax on amount you choose to convert. For 2010 and beyond there’s not income limit prohibiting you from making the conversion – as there has been.

Holding money in a Roth IRA keeps it safe from future increases in income tax rates that plague holders of ‘deductible contributions’ plans.

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