New York Estate Planning & Elder Law Blog
Not all investments are created equal. You investment portfolio may include a 401(k), individual retirement account, pension plan, or deferred compensation plan, among others investment vehicles. Whether your investment trust account is qualified under the Internal Revenue Code will determine the tax treatment of your contributions and withdrawals.
Qualified vs. Non-Qualified Investment Accounts
A tax-qualified account features the ability to contribute income to the qualified account and defer tax on the account funds. Typically, you must be 59 ½ to withdrawal funds from a tax-qualified account without penalty. Conversely, non-qualified accounts do not offer tax deferred treatment. When you withdraw funds from a tax-qualified account, your entire withdrawal will be taxable, as opposed to being taxed on only the growth of your non-qualified account. Qualified tax plans include, but are not limited to:
- 401(k) plans;
- 403(b) tax-sheltered annuity plans;
- traditional individual retirement arrangements;
- savings incentive match plan for employees;
- simplified employee pension plans;
- 457(b) deferred compensation plan;
Minimum Distribution Requirements
After years of saving for retirement, there will come a time when you will have to withdraw money from your investment accounts. With respect to your tax-qualified investment accounts, the Internal Revenue Service has decided that this time will begin, at least in part, when you reach the age of 70 ½. The requirement to withdraw funds at this age is a mandate from the Internal Revenue Code’s required minimum distribution rules. A required minimum distribution (RMD) is the minimum annual amount you must withdraw from your account. Generally, the money you withdraw will be taxable. The amount you will be required to withdrawal depends upon your account balance and life expectancy.
Tax Planning
For most accounts, your first required minimum distribution should be taken by the first day of April in the year following the end of the calendar year in which you reach the age 70 ½. For instance, if your 70th birthday was May 5, 2015, you turned 70 ½ on November 5, 2015, and your first required minimum distribution must be taken by April 1, 2016. For the second year, and every year thereafter, you must take your annual required minimum distribution by December 31st. If you fail to take your required minimum distribution in any given year, you will be penalized by the Internal Revenue Service. The penalty is 50% of the required minimum distribution amount you were supposed to have taken. To avoid hefty penalties you should meet at least annually with your tax advisor to ensure your are withdrawing the required amounts. Often it is helpful to couple this practice with a review of your estate plan, so you are making appropriate decisions that optimize your investments as you grow older.