There are 4 stages in the lifecycle of your IRA, and each one gets progressively more complicated.
The last stage is “What happens when I’m gone?”
Here is what you need to know about each stage leading up to the last:
Before age 59 1/2, you are usually paying into the IRA. But if you try to take anything out, you pay the taxes plus a 10% penalty.
After 59 1/2, you can take funds from your IRA if you like, and pay the tax. But you can also just leave it in and let it grow…
After you turn 70 1/2, then you must start taking funds out. How much you take out is based on your age. The term for this is the “Required Minimum Distribution” or RMD. This requires that you take out a certain percentage every year, based on your age. The IRS has a table that says how much you have to take out. To calculate your first RMD, take the value of your IRA at the beginning of the year and divide by 27.4. The second year you divide by 26.5 and so on, based on the table. The good news is that even at age 100, the IRS table still estimates that you have over 6 years to live!
So, what’s the next stage of your IRA?
After you die. At that point, the IRA will take one of two forms:
1) If you leave it to your spouse, then the spouse can just take it and add it to their IRA.
2) If you leave it to your kids or others, then they can’t put it in their IRA. Instead, they will keep it separate as an inherited IRA. At that point, they are required to begin taking those minimum distributions (RMD’s) based on their life expectancy. It doesn’t matter what age your child is, they have to begin taking money out annually after your death. For instance, if you leave your IRA to a child who is 47-years-old, then she has to take out at least 1/37th of the IRA the first year, 1/36th the next year, 1/35th the next, and so on.
With IRA planning, the key is how we handle this after-death stage. There are quite a few planning tricks that can help, plus plenty of traps for the unwary. We will address some of those traps in next week’s post.