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The Truth About Protecting Your IRAs and 401(k)s: The Magic Numbers 59 1/2 and 70 1/2

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Throughout the laws pertaining to withdrawals from annuities, traditional IRAs, and 401(k)s are found the recurring numbers 59 1/2 and 70 1/2. These numbers seem to take on almost mythical proportions. Most of us assume that there are logical reasons behind these numbers and assume, in particular, that the mystical 1/2 years contained in each of these numbers must have tremendous significance. However, to assume this is to give Congress much more credit than it deserves.
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The age of 59 1/2 is the age at which you can withdraw money from retirement accounts without penalties. It’s certainly understandable to have some kind of age prior to which there’s a penalty for early withdrawal from a retirement account, because when Congress enacted the laws giving taxpayers tax breaks and inducements to save for their own retirement through these programs, allowing people to have total access at any time to these funds that are intended for retirement would just defeat the whole purpose of encouraging such savings. But why 59? And why the extra half a year to make it 59 1/2? The answer goes back to the creation of the Keogh Plan. The Keogh Plan was one of the earliest Congressional attempts to encourage people to save for their own retirement. It was named after one of its sponsors, New York Congressman Eugene Keogh. In 1962, Congress was debating the Keogh Plan’s imposition of penalties before a designated “normal” retirement age and the maximum age for people to withdraw money from their tax-deferred retirement accounts so that the government could receive tax payments on the withdrawals. House and Senate committee reports indicated that the age of 60, which was a common retirement age in 1962 was, as determined by insurance company actuaries, to be actually 59 1/2 years in insurance years. No mention was made of the retirement age of 60 being 8.5714285 in dog years, but that may just be a Congressional oversight. It seemed a natural fit for Congress to conform the new retirement plan legislation with the existing policy structures then used by insurance companies, including the half-year “insurance age” designations. Thus, 59 ½ was born.

As for age 70 1/2 being the outside age at which withdrawals must be commenced from annuities, traditional IRAs, and 401(k)s to avoid tax penalties, the age of 70 has had a long history in retirement planning. In 1889, the age of 70 was used in Germany as the retirement age in the first national old-age retirement system. During the 1930s, prior to the Social Security system being enacted, about half of the state pension systems then in effect used the age of 70 as retirement age. Although for consistency’s sake you might think that 70 1/2 is the insurance age equivalent to age 70, this is not correct. The 70 1/2 may have come just in an effort to make things appear consistent with the early withdrawal penalty age of 59 1/2, or it may have been chosen in response to a 1960 report of the Social Security Administration that indicated that the average life expectancy of men who would be contributing to self-employed retirement plans like the Keogh Plan was 70.45 years.

Of course, making things even more complicated are the confusing rules that indicate how the 70 1/2 mandatory withdrawal age is applied. According to the rules, you are not actually required to take out your first minimum withdrawals from your annuity, traditional IRA, or 401(k) in the year in which you turn the magic age of 70 1/2. Ironically, you are not actually required to take out your first minimum withdrawal until April 1 of the year after you turn 70 1/2. However, if you do decide to postpone your withdrawal of your first minimum withdrawal amount until that next year in an effort to further defer the payment of income taxes on the amount to be withdrawn, you put yourself in the position of having to also take out a minimum withdrawal amount for the year following the year in which you turn 70 1/2, thereby requiring you to take out two years’ worth of minimum annual withdrawals in one year, which may result in a significantly larger tax hit in that year.

But what happens if you do not start taking your minimum required withdrawals in a timely fashion? Such procrastination can result in a serious penalty. Your failure to take out the minimum required distribution in a timely fashion brings with it a penalty equal to 50% of the required distribution that you did not take. The IRS has been waiting somewhat patiently to get its hands on tax money from your retirement accounts. It does not take kindly to people stretching the envelope and trying to extend the time during which they pay no taxes on their retirement accounts.

If you find that you did not take your minimum required distribution on time, you can always try to use the “dog ate my homework” defense and argue that your failure to take the proper distribution was due to a “reasonable error” on your part and that you are correcting the problem and taking the required distribution now. Doing this requires you to file an IRS Form 5329 as well as pay the 50% excess accumulation tax. Include a letter of explanation (unlike the homework example, a note from your mother will not suffice), hope for the best, and if the IRS is in a charitable mood, it may refund your excess tax penalty.

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