Top 5 IRA features every retiree should understand

By the end of your career, it is not unusual for most of your retirement savings to be in a retirement account like a workplace retirement plan. By using these types of accounts, you have enjoyed tax deductions and tax-deferred growth over the lifetime of your work history. Once you leave your employer, you may choose to roll over your retirement savings to an IRA for increased control over your account and your investments.

To help navigate the complex maze of IRA rules, here are five characteristics of IRAs that every retiree should know.

1. Updated required minimum distribution (RMD) schedule

Withdrawals from traditional IRA accounts are taxed at ordinary income tax rates. Even if you don’t need to withdraw from these retirement accounts for living expenses, the IRS mandates that you start taking a required minimum distribution (RMD) each year. The specific amount is calculated based on the account value at the end of the year, your age, and a factor from the IRS’s actuarial tables.

The original SECURE Act raised the age at which RMDs must begin to 72. The SECURE 2.0 Act further increased the RMD age to 73 starting in 2023 and to 75 starting in 2033. This change allows retirees to keep their savings in their retirement accounts longer, potentially benefiting from continued tax-deferred growth.

In case you haven't paid attention to your RMD schedule, you still may have time to correct the error with minimal penalties. Prior rules imposed a penalty of 50% of the amount not withdrawn. However, SECURE 2.0 reduces this penalty to 25%. If the error is corrected within two years, the penalty is further reduced to 10%.

2. Qualified charitable distributions

A qualified charitable distribution (QCD) is a direct transfer of funds from your IRA, payable to a qualified charity. The key advantage of a QCD is that the amount transferred counts toward your RMD for the year, but it is excluded from your taxable income. This can provide significant tax savings, especially for those who do not itemize deductions. Below are some of the requirements for a distribution to qualify as a QCD:

• You must be at least 70½ years old at the time of the distribution to qualify for a QCD. Notice that you can start making QCDs before the updated RMD age which could reduce your account balance on which future RMDs are calculated.
• In 2024, you can donate up to $105,000 as a QCD. The annual limit is indexed for inflation each year.
• The donation must go directly to a qualified 501(c)(3) organization. SECURE 2.0 expands the types of entities that can receive QCDs to include charitable remainder trusts, charitable gift annuities, and similar entities.
• The funds must be transferred directly from the IRA to the charity. If you withdraw the funds and then donate them, they will not qualify as a QCD and will be subject to taxes.

3. 72(t) distributions

Should you need to access the funds in your IRA before age 59½ you may be able to avoid the 10% early withdrawal penalty by using a 72(t) distribution. A 72(t) distribution, named after Section 72(t) of the Internal Revenue Code, allows for penalty-free early withdrawals from an IRA or other qualified retirement plan so long as these distributions are taken as substantially equal periodic payments (SEPPs) over the account holder's life expectancy. Some key things to note about 72(t) distributions are:

• Once you start 72(t) distributions, you must continue them for at least five years or until age 59½, whichever is longer. Any modification to the payment schedule will result in retroactive penalties and interest.
• The IRS allows for three methods to calculate the SEPPs: (1) the Required Minimum Distribution Method; (2) the Fixed Amortization Method; and (3) the Fixed Annuitization Method.
• Calculating the correct payment amounts can be complex and may require professional assistance to avoid costly errors.
• Since distributions are based on the account balance, market downturns can significantly affect the sustainability of your payments, especially with the RMD method.

4. Beneficiary designations

IRAs allow you to name beneficiaries to the specific IRA account, and if done properly, this allows the assets to bypass probate and pass directly to your beneficiaries. You want to make sure that you clearly designate primary and contingent beneficiaries on your IRA.

You also may want to specify if you want the inheritance to be distributed per stirpes (down the family line) or per capita (equally among surviving beneficiaries). You should also check your beneficiary designations regularly and confirm that they are up to date. Failing to do so can result in unintended individuals inheriting your IRA.

Under the SECURE Act, most non-spouse beneficiaries must withdraw all assets from an inherited IRA within 10 years. Withdrawals from traditional IRAs will be taxed as ordinary income to the beneficiary. Certain beneficiaries, like spouses, minor children, disabled individuals and those not more than 10 years younger than the decedent, may qualify for different distribution rules, potentially allowing them to stretch distributions over their lifetimes.

5. Roth IRA conversions

Any advice or tips involving Roth IRAs always get a lot of buzz, including Roth IRA conversions. But do Roth IRA conversions still make sense in retirement? As a recap, a Roth IRA conversion is when you convert a traditional IRA to a Roth IRA. Ordinary income tax is paid on the amount converted, but the new Roth IRA balance can grow tax-free, and there are no RMD requirements during the original account holder’s lifetime.

Roth IRA conversions could make a lot of sense if you stop working and have a few years between when you last drew a paycheck and when you start collecting social security and taking RMDs. You can possibly use up lower tax brackets, in the 10% and 12% range, to convert the balance to a Roth IRA, which may be significantly lower tax brackets than if you waited until later years when social security and RMDs are factored in.

There are many opportunities and areas of caution when incorporating IRAs into your retirement plan. Creating an optimal plan requires careful attention to beneficiary designations, tax implications and the specific rules governing IRAs.

Regularly reviewing and updating your plan to reflect changes in laws and your personal circumstances and working with qualified financial professionals can ensure you create a comprehensive strategy that aligns with your financial goals.

This article was written by Alexandra Demosthenes from The Street Retirement and was legally licensed through the DiveMarketplace by Industry Dive. Please direct all licensing questions to legal@industrydive.com.