Because the Individual Retirement Account (IRA) was created as part of the Internal Revenue Code, there is nothing simple about the way it works. There are a number of traps that can end up hurting you if you're not careful.
One of this is failing to take a Required Minimum Distribution (RMD) every year after you turn 70-1/2. The RMD is first due by April 1 of the year after the year in which you turn 70-1/2. Once RMDs begin they must be taken every year by December 31. If an RMD isn't made, or is made in an amount less than the RMD required, the IRS imposes a 50% penalty on the shortage. The amount of the RMD is determined by dividing the IRA balance as of December 31 of the prior year (after that year's RMD) by one of three life expectancy factors. Be sure you use the right one!
Here's how it would work for an 85-year old whose IRA balance is $900,000 as of December 31, 2011: Using the life expectancy factor of 14.8, the RMD for 2012 would be $60,811 ($900,000/14.8). If this person failed to take any RMD the IRS would impose a penalty of 50% of $60,811, or $30,405.50. If the person took a distribution of $50,000, the penalty would be 50% of $10,811 (the shortage), or $5,405.50. Of course, you can take more than the RMD without penalty; you just have to take the minimum each year.
If you have more than one IRA the RMD is calculated on the total of all IRAs and can be taken from any or all of them. So if the person in the above example had two IRAs, one of $500,000 and one of $400,000, he could take the distribution equally from both, all from one or the other, proportionally from each or however he wants. One thing he should do is re-balance the account from which the distribution is made after he takes it.
With the year end approaching watch out for tax traps.
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