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Planning Pension Distributions

Article Highlights

  • Except for distributions from Roth IRAs, pension distributions are generally taxable.
  • Pension distributions can increase the tax on your Social Security benefits.
  • Pension distributions can increase your marginal tax rate.
  • IRA-to-charity transfers are allowable in 2013.

An individual may begin withdrawing, without penalty, from his or her qualified pension plans and Traditional IRAs at the age of 59½. There are several exceptions that will allow earlier withdrawal without penalty. Upon reaching age 70½, you are required to take distributions from your plans or face a substantial penalty for failing to do so. An exception applies for Roth IRAs: no distributions are required while the account owner is alive (Roth distributions are generally tax-free anyway).

  • Impact of Your Marginal Rate: If you are able to plan your withdrawals, you can save considerable tax dollars. This is not always possible, but the basic premise is to take distributions and pay the resulting tax in years when your marginal rate is low. Also watch for years when, for a variety of reasons, your taxable income is negative and some amount of distributions can be taken tax-free at ages 59½ and over. The early withdrawal penalty applies only to those under 59½.
  • Impact on Social Security: For retired individuals receiving Social Security benefits, planning IRA distributions can also be beneficial. Social Security itself is taxable only when the total of one-half of the taxpayer's Social Security benefits plus the taxpayer's other income exceeds $25,000 ($32,000 for a married couple filing jointly). Once this threshold is reached, every additional dollar of other income will cause 50% to 85% of the Social Security benefits to become taxable as well. Therefore, if a taxpayer's other income is below the threshold, it is generally good practice to withdraw just enough taxable IRA funds to bring the income up to the threshold amount, even if the funds are not needed in that year. They can be set aside for a future year when they might be used for some unplanned need or large purchase. This strategy may not work, however, if IRA distributions are required to be made (see next section).
  • Minimum Distribution Requirements: The IRS does not allow taxpayers to keep funds in qualified plans and IRAs indefinitely. Eventually, assets must be distributed and taxes paid. If there are no distributions, or if the distributions are not large enough, the owner may have to pay a 50% penalty of the amount not distributed as required. Generally, distributions must begin in the year in which the plan owner reaches the age of 70½. In most cases, the required minimum distribution can be figured with the “life” factor from the following table, which is divided into the value of the account as of the end of the preceding tax year. So, for example, an individual who reaches age 73 in 2013 and whose IRA had a value of $50,000 on December 31, 2012, would be required to withdraw $2,024.29 in 2013 ($50,000/24.7).

IRA-to-Charity Contributions: If you are at least 70.5 years old and are thinking of making a donation to a charity, you may wish to consider making the contribution from your IRA account.

For 2013 (this is the last year without an extension by Congress), you can donate up to $100,000 to your favorite charity - provided it is an eligible charitable organization - tax-free from your Traditional IRA, Roth IRA, SEP, or SIMPLE IRA. To be considered valid, the distribution from the IRA to the charity must be made directly. It cannot pass through your hands or through other accounts. Note: These distributions are not permitted from ongoing SEP or SIMPLE plans - that is, plans to which a contribution has been made for the year.

Here are the pertinent facts about making a donation using this provision of the law:

  • The distribution is not taxable and does not add to your income for the year. The advantage is that it keeps your income low and helps minimize your taxable Social Security income and tax disadvantages associated with higher income.
  • There is no charitable donation, since the distribution was tax-free. This can be a considerable benefit, however, to taxpayers who take the standard deduction and do not itemize anyway.
  • If you have not already taken your required minimum distribution (RMD) for the year, the charitable distribution can count toward this year's RMD.

If you need assistance planning your pension distributions, please give this office a call.