IRA Distributions

The intent of Congress in creating IRAs was to provide retirement income. To discourage premature withdrawals, the tax code imposes a 10% penalty tax on most withdrawals taken before the IRA holder reaches age 59½. By the same token, IRA funds are intended to be used for retirement, so the law mandates minimum distributions beginning at age 73 (per SECURE Act 2.0). Failure to take the required minimum distribution is subject to a 25% excise tax (reduced to 10% if corrected within two years). These penalty taxes are in addition to the regular income tax due in the year of distribution.

Distributions from IRAs funded entirely with tax-deductible contributions are fully taxable to the recipient as ordinary income. Since taxes have not been paid on either contributions or earnings, the entire amount is subject to tax when withdrawn.

Contributions to nondeductible IRAs are made with after-tax dollars, which grow tax-deferred. When withdrawn, a portion reflects return of contributions (already taxed) and a portion represents taxable earnings. Only the earnings portion is taxable as ordinary income. The following formula is used to find the non-taxable portion:

Some IRA owners elect to receive distributions as a series of installment payments — commonly as an annuity over the life of the holder or the joint lives of the holder and a designated beneficiary. Regardless of the payout structure, a portion of each payment corresponding to after-tax contributions is received tax-free; the remainder is taxed as ordinary income.

For lifetime annuities, the expected return is determined using IRS life expectancy tables. If after-tax contributions have been fully recovered during the annuitant’s lifetime, the entire annuity payment becomes taxable. If the annuitant dies before recovering all after-tax contributions, the estate may claim a deduction on the final income tax return for the unrecovered amount.

The IRS imposes a 10% penalty tax on most premature distributions — those taken before the IRA owner reaches age 59½. Exceptions to this penalty are made for distributions:

• To a beneficiary upon the IRA holder’s death
• Taken due to the holder’s disability
• That are part of a series of substantially equal periodic payments (at least annually) made for the life of the IRA holder or the joint lives of the holder and beneficiary
• Made under a divorce decree (qualified domestic relations order)
• For qualified higher education expenses of the taxpayer, spouse, children, or grandchildren
• For qualified first-time homebuyer expenses (subject to a lifetime maximum of $10,000 from all IRAs)
• For significant medical expenses in excess of 7.5% of adjusted gross income, or to pay health insurance premiums after separation from employment
• Rollovers and transfers to other IRAs or qualified plans
• Made due to an IRS levy on the IRA
• For qualified reservist distributions (military personnel called to active duty for 180+ days)
• Qualified disaster distributions up to $22,000 (added by SECURE Act 2.0)
• For long-term care insurance premiums up to $2,500/year beginning in 2026 (added by SECURE Act 2.0)

Unless a premature distribution qualifies for one of these exceptions, it is subject to the 10% penalty tax in addition to ordinary income tax. Once the IRA holder reaches age 59½, withdrawals are no longer subject to the penalty and are simply taxed as ordinary income.

If an IRA holder dies before the required beginning date for minimum distributions (i.e., before reaching RMD age of 73) and no beneficiary was named, the entire account must be distributed to the IRA holder’s estate no later than December 31st of the fifth year following the holder’s death (“the 5-year rule”).

If a beneficiary was named, distribution rules depend on the relationship to the deceased, as described in the IRA Beneficiaries section. For most non-spouse beneficiaries, the SECURE Act’s 10-year rule now applies — requiring the entire balance to be distributed by the end of the 10th year following the owner’s death. (See IRA Beneficiaries →)

If the sole beneficiary is a surviving spouse, the spouse may elect to:

• Roll over the inherited IRA into his or her own IRA, becoming the new owner and subject to his or her own RMD rules
• Remain as beneficiary and defer distributions until the deceased spouse would have reached RMD age (73)
• Take distributions based on his or her own life expectancy

If the spouse elects to treat the inherited IRA as his or her own account, minimum distributions based on the spouse’s life expectancy must begin when the spouse reaches age 73. A surviving spouse who rolls over an inherited IRA may designate a new beneficiary, potentially extending the distribution period.

If the holder dies after required minimum distributions have begun, individual beneficiaries and trusts calculate continued distributions based on their life expectancies under the applicable rules. Non-individual beneficiaries (estates and charities) must take distributions based on the deceased holder’s remaining life expectancy.

If a beneficiary inherits an IRA from a person who had a cost basis (nondeductible contributions), that basis remains with the IRA. Unless the beneficiary is the spouse who elects to treat the IRA as his or her own, the beneficiary cannot combine this basis with any basis in other IRAs. Distributions from an inherited IRA and the beneficiary’s own IRA must be calculated separately.

The total value of any IRAs, including death benefits payable as an annuity, is included in a decedent’s gross estate for estate tax purposes. Beneficiaries who receive IRA distributions must include them in their taxable income.

The law defines a “disabled person” as one who is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or to be of long-continued or indefinite duration. This definition is broad, making it difficult to qualify. To establish disability, the participant must furnish a medical report certified by a licensed physician. Once established, the 10% penalty tax is waived — the participant can receive distributions before age 59½ but must report them as income.

When an IRA is transferred pursuant to a legally binding divorce or separation agreement, it is not taxed. Neither the IRA owner nor the recipient is subject to taxes or the 10% withdrawal penalty upon transfer. Starting from the date of the transfer, the IRA is treated as the account of the former spouse who receives it, and all usual IRA rules apply from that point.

The IRA may be transferred by direct trustee-to-trustee transfer, rolled over into the ex-spouse’s existing IRA, or simply retitled in the name of the recipient spouse. In the rollover method, the rollover must be completed within 60 days of the withdrawal.

Distributions can be taken from an IRA without penalty before age 59½ if the payments are made in a series of substantially equal installments over the participant’s life expectancy (or joint life expectancy). The payments must be made at least annually. The participant faces severe penalties if the payment schedule is changed before reaching age 59½ — the deferred penalty taxes on all prior distributions become immediately due, plus interest.

Distributions may be taken in any amount after age 59½ without penalty, subject only to ordinary income taxes. A traditional IRA holder must begin taking RMDs no later than April 1st of the calendar year following the year in which the individual reaches age 73. Subsequent distributions must be made by December 31st of each year thereafter.

The minimum distribution for each year is determined by dividing the prior December 31 value of all IRA accounts by the applicable life expectancy factor from the IRS Uniform Lifetime Table. The IRS updated this table effective 2022, reflecting longer life expectancies.

When the first required distribution is deferred until April 1st of the following year, the account balance used for the second distribution must be adjusted to reflect the delayed first payment.

If the sole beneficiary is a spouse more than 10 years younger than the IRA holder, a separate Joint Life and Last Survivor Table may be used, resulting in a longer distribution period and smaller annual RMD.

For IRA holders with multiple IRA accounts, the minimum distribution must be calculated for each account separately. The IRS permits the holder to add these individual minimums together and withdraw the aggregate from any one or combination of IRAs.

The IRS requires IRA custodians to withhold federal income tax on IRA distributions. For annuities or other periodic distributions, recipients may elect to have no taxes withheld. Lump-sum distributions are always subject to a 20% withholding rate — recipients may not opt out. Similarly, distributions payable outside the United States may not elect out of withholding. Rollovers are subject to 20% withholding; direct trustee-to-trustee transfers are not.

IRA rollovers and transfers are tax-free movements of funds from one IRA to another IRA or from a qualified retirement plan to an IRA. A rollover involves the account holder actually receiving the funds and then re-depositing them in a new IRA. A transfer moves funds directly from trustee to trustee without the holder taking possession. These mechanisms allow individuals to change investments, consolidate accounts, or change custodians without tax consequences.

Two general conditions must be met for a tax-free rollover:

• The distributed amount must be transferred to the new IRA no later than 60 days after it was received
• Rollovers from the same IRA can occur only once per year (the one-rollover-per-year rule applies per IRA, not per person)

If the amount withdrawn is not rolled over within the 60-day period, it must be included in gross income in the year of receipt. All rollover distributions are subject to 20% income tax withholding, meaning only 80% of the distribution is available for reinvestment unless the holder contributes additional personal funds to make up the withheld amount.

A direct transfer differs from a rollover in that funds are paid directly from one trustee to another without the holder taking possession. The transferred amount is not included in the holder’s gross income. There is no limit on how frequently direct transfers may be made, and they are not subject to income tax withholding. For these reasons, direct transfers are the preferred method of redeploying IRA assets.

• Required minimum distributions
• Corrective distributions of excess contributions
• Any distribution that is part of a series of substantially equal periodic payments over the life of the employee or a period of at least 10 years
• IRA balances inherited by a non-spouse beneficiary (a surviving spouse may roll over an inherited IRA)

If a retirement plan trustee distributes property (other than cash), the account holder may roll over the same property into another IRA. If stock is received from the old IRA, the same stock must be rolled over to the new IRA. The holder may also sell the property and roll over the proceeds to an IRA within the 60-day period. Prohibited investments (such as life insurance) may not be rolled over; only the cash surrender value of a life insurance policy may be rolled into an IRA.

A Conduit IRA is used to temporarily “park” a distribution from an old employer’s qualified plan while the individual between jobs, enabling a later tax-free rollover into a new employer’s plan. To remain eligible for this later transfer, the Conduit IRA must not be “contaminated” with other IRA contributions. If the individual also wishes to make regular IRA contributions during this period, a separate IRA should be established for that purpose.

Distributions from SIMPLE IRA accounts are generally taxed like distributions from a traditional IRA, but some special rules apply. During the first two years of participation, a participant may roll over distributions only from one SIMPLE IRA to another SIMPLE IRA tax-free. A rollover from a SIMPLE account to a regular IRA (or other qualified plan) is penalty-free only after the individual has participated in the SIMPLE plan for two years.

Early withdrawals from a SIMPLE account during the first two years of participation are assessed a 25% penalty tax rather than the normal 10%. After the two-year period, the standard 10% penalty applies to premature distributions. The 25% tax does not apply to distributions after age 59½, or due to death or disability, regardless of how long the individual has participated.