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Individual Retirement Account - Required Minimum Distribution

If you have one or more traditional IRAs set up in your name and will be age 70 1/2 or older at year-end. You must comply with the so-called required minimum distribution (RMD) rules or face a stiff penalty. These rules force older account owners to take annual withdrawals from their IRAs and pay the resulting extra federal income tax. The same rules also apply to simplified employee pension (SEP) accounts and SIMPLE-IRAs, because they count as traditional IRAs for this purpose. (Thankfully, if you own one or more Roth IRAs, those accounts are exempt from the RMD rules for as long as you live.)

If you think the RMD rules are just a minor nuisance that you can ignore, think again! If you fail to withdraw at least the annual RMD amount, the IRS can assess a 50 percent penalty on the shortfall (the difference between the RMD amount you should have withdrawn for the year and the actual amount you did withdraw). It's one of the harshest tax penalties on the books.

Your first RMD is for the year you turn 70 1/2. Then, you must take another RMD for each succeeding year for as long as you live or as long as you have a balance in one or more traditional IRAs.

Your annual RMD amount equals the total of your traditional IRA balances (including any SEP or SIMPLE-IRA balances) as of December 31 of the previous year divided by a life expectancy divisor provided by the IRS.

The RMD amount must be recalculated annually, because your IRA balance as of the end of the previous year is a moving target, and so is the life expectancy divisor. As you grow older, the life expectancy divisors get smaller and smaller, which means the annual RMDs become a bigger and bigger proportion of the IRA balance. See the SIDEBAR for the table of life expectancy divisors that most IRA owners should use.

In January of each year, your IRA custodian or trustee is supposed to notify you if an RMD must be taken for that year and tell you the amount. You may be able to arrange to have that amount distributed to you automatically in a lump sum or monthly or quarterly installments. However, don't take anything for granted. By knowing how the RMD rules work and by taking personal responsibility for complying with them, you can be certain that you will not get hit with the 50 penalty.

If You Turn 70 1/2 This Year

Your initial RMD is for the year you turn age 70 1/2. Thanks to a special timing rule that only applies to that initial RMD, you have two options for when to withdraw it.

Option No. 1: Take Initial RMD before Year End. The first option is to take the initial RMD by December 31 of the year you turn the magic age. So if you turn 70 1/2, this year and choose this option, you should take your initial RMD by no later than December 31, 2012.

Option No. 2: Take Initial RMD Next Year. The other option is to take your initial RMD by no later than April 1 of next year (the year after the year you turn 70 1/2). However, if you choose this option, you must withdraw your first and second RMDs next year.

If You Turned 70 1/2 before this Year

If you turned 70 1/2 in 2011 or earlier, your RMD situation is pretty simple. Withdraw at least the RMD amount for your 2012 tax year by no later than December 31, 2012. To calculate the amount, divide the combined balance of all your traditional IRAs as of December 31, 2011 by the life expectancy divisor from the table, based on your age as of December 31, 2012.

If You Have Multiple IRAs

As explained earlier, when you own several traditional IRAs (including any SEP accounts or SIMPLE-IRAs), you must withdraw at least the annual RMD amount based on the combined balance of all those accounts. However, there's no requirement to actually withdraw money from any specific account. As long as you withdraw the proper RMD in total, you can take the money out of as few or as many accounts as you wish.

Beneficiary of a Deceased Individual's Tax-Favored Account

If you are the beneficiary of a deceased person's traditional IRA, Roth IRA, or qualified retirement plan account (such as a 401(k) account), you must comply with a separate set of RMD rules for inherited accounts. Depending on the circumstances, it may be necessary to withdraw an RMD by as early as December 31, 2012 in order to avoid the 50 percent penalty.