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If you recently retired, or are about to, there are a few things you should know about your IRA. And, even if you don't have an IRA, most of these points apply to 401(k)s and other retirement plans as well. With that in mind, don't spend another day in retirement without knowing these essential IRA facts.
RMDs: Required Minimum Distributions
If you have a traditional IRA, you must start taking distributions at age 70 and 1/2.
Specifically, you need to take your first required minimum distribution (RMD) by April 1 of the year following the calendar year in which you turn 70-1/2. For example, if you reach the age of 70-1/2 in 2017, you'll need to take a distribution by April 1, 2018, and again by December 31 of 2018, and of each year that follows.
The amount you'll have to withdraw each year depends on your account balance and your age. The IRS provides tables of life expectancy factors that can tell you how much you'll need to withdraw. For example, the Uniform Lifetime Table, which applies to most people, lists a factor of 27.4 for a 70-year-old retiree.You can calculate your RMD requirement by dividing your account balance by this number -- if you have $500,000 in your traditional IRA, this translates to a first-year RMD requirement of $18,248.
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You can choose to take your RMD in a lump sum, or spread it out over time, such as dividing it into monthly payments throughout the year. As a word of caution, be careful of waiting until the last minute for your first RMD, as this would cause you to withdraw your first and second RMDs during the same calendar year, which could make for a massive tax bill.
Don't miss your RMD -- the penalty is severe. If you don't take a required RMD, you'll be penalized 50% of the amount you were supposed to take.
The same requirement applies to all pre-tax retirement accounts, including most 401(k) and 403(b) accounts. On the other hand, Roth IRAs have no such requirement. Since you've already paid taxes on the money you contributed to a Roth, you are free to let it grow for as long as you'd like.
How your distributions are taxed -- and their implications on Social Security
When you withdraw money from a traditional IRA, or any other pre-tax retirement account for that matter, the distribution is treated as taxable income. In other words, if you withdraw $40,000 from your traditional IRA this year, it will be treated in the same manner as if you earned a $40,000 salary from a job. Roth distributions are not taxable since you pay tax on the money you contribute to a Roth account.
Depending on the amount of your withdrawals, this can cause your Social Security benefits to be taxed as well. Here's a thorough look at whether or not Social Security benefits are taxable, but as a general rule, if Social Security is your only source of taxable income in retirement, your benefits won't be taxed. On the other hand, if your combined income (including taxable retirement distributions) results in your income exceeding certain thresholds, up to 85% of your Social Security benefits can be subject to income tax.
To be able to contribute to any IRA, you (or your spouse) need to earn eligible compensation, which includes wages, salaries, tips, or commissions. Social Security or pension income doesn't count, nor does other investment income. For 2016, you can contribute the lesser of your earned compensation, or $5,500 ($6,500 if you're over 50).
For a traditional IRA, eligible individuals can contribute during years before they attain the age of 70-1/2. As an example, if you turn 70-1/2 in October 2016, you cannot contribute to your traditional IRA at all for the 2016 tax year.
Roth IRA contributions have no age limitations, but the compensation-based eligibility requirement still applies. If you're 75, have earned income, and want to make a Roth IRA contribution, you're free to do so.
The bottom line
There are a lot of things investors should know about their IRAs, and these three things are especially important for retirees. With this knowledge, you can be sure to take your RMDs in a timely manner and anticipate and plan for taxes, both on your distributions and Social Security benefits. And, you'll know when to finally stop contributing to your account. The bottom line is that the more you know about your IRA, the better prepared for a comfortable retirement you'll be.
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