Smart IRA withdrawal strategies

  • By Fidelity Viewpoints
  • May 06, 2013

smart IRA withdrawal strategies

Knowing your income needs and options is key.

Every year, if you’re age 70½ or older, you generally need to withdraw a certain amount of money from your traditional IRA, 401(k) plan, or other workplace savings plan. These minimum required distributions—known as MRDs or RMDs—are usually taxed as ordinary income. (Part of these distributions may be nontaxable if you've made after-tax contributions to these accounts.)

It’s important to determine how they fit into your overall retirement income plan, especially if you need the cash flow to cover expenses. While the IRS requires you to take MRDs, you have some flexibility on timing and what to do with the money. For instance, if you don’t need it for living expenses, you may want to give it your heirs or a charity. “Building a sound retirement income plan—one that can match your income sources with your expenses—is a critical component in achieving overall financial success during retirement,” says Ken Hevert, Fidelity vice president of retirement products. “Making the best use of your savings and distributions can help avoid costly mistakes. And if you don't absolutely need the money, you can make some decisions about the best way to use it."

Here are four key questions that can help you come up with an MRD strategy.

Do you need the money to cover living expenses?

“If you’re planning to spend your MRDs, one big consideration is managing your cash flow,” explains Hevert. “You may want to consider arranging to have payments sent directly to a cash management account that provides flexible access to the money with features such as checkwriting, ATM use, and online bill payment.”

Arranging to have the money automatically distributed to a cash management or taxable brokerage account also helps to ensure that your MRD requirement will be met by the deadline of December 31 each year, avoiding an IRS penalty on distributions made after the deadline. When planning your budget, bear in mind that you’ll generally owe income tax on any MRDs and other distributions from traditional retirement accounts. You can have taxes automatically withheld from your MRDs. If you choose not to do this, make sure you set money aside for tax time.

There are a few different “automatic” withdrawal methods that you may want to consider to help you satisfy your MRD requirement:

  • IRS recalculation method: This is the required method of calculating your MRD according to IRS rules. It generally requires annual distributions1 from your account based on your life expectancy, and is recalculated each year.

  • Purchasing an annuity: The purchase of an annuity can help turn your IRA assets into a stream of income payments, guaranteed for life.2,3 (Important note: This method does not guarantee that you will comply with the IRS MRD regulations or meet your MRD obligations. Only the amount of money being annuitized will be counted as your MRD.) This guarantees a set payment option for retirement income, regardless of your life expectancy,4 and helps reduce your risk of a budget shortfall. In addition, it provides more income beyond life expectancy than other options.5 There are two options to consider when deciding whether the purchase of an annuity may be right for you and your retirement income plan:

    • Fixed payment option: Lifetime payments remain level, and access to additional principal withdrawals is limited.

    • Variable payment option: Lifetime payments vary over time, based on performance of the underlying investments you choose. In some cases, additional withdrawals after purchase may be allowed.6
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Before investing, consider the fund's investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus containing this information. Read it carefully.

1. Taxable amounts withdrawn prior to age 59½ may be subject to a 10% IRS penalty in addition to ordinary income tax.

2. Guarantees are subject to the claims-paying ability of the issuing insurance company. In return for a variable lifetime income benefit, the issuing company does assess an insurance charge.

3. In the event of your premature death, the issuing insurance company may provide your spouse or beneficiary with either a lump-sum payment or continued payments over the remaining guarantee period.

4. Ibid., endnote 2, above.

5. Ibid., endnote 2, above.

6. Ibid., endnote 1, above.

7. A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, become disabled, make a qualified first-time home purchase, or die.

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The tax and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

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