Don't blow off IRA withdrawals

This postcomes fromBill Bischoffat partner site SmartMoney.

If you own one or more traditional individual retirement accounts and will turn 70½ this year, get ready to start taking mandatory annual payouts and paying extra income taxes. In fact, the whole reason our pals in Congress dreamed up the so-called required minimum distribution idea was to force IRA owners to pay additional taxes sooner rather than later.

Unfortunately, complying with the RMD rules is not something you can afford to put off. If you fail to take at least the required amount each year, the Internal Revenue Service can assess a 50% penalty on the shortfall (the difference between what you should have taken out and what you actually took, if anything).

Keep in mind that simplified employee pension or SEP accounts and Simple IRAs are considered traditional IRAs for purposes of the RMD rules. So you have to consider these accounts along with any garden-variety traditional IRAs set up in your name when figuring out how much you need to withdraw to avoid the dreaded 50% penalty.

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If you have several accounts, you can take the required annual amount from any one account or from any combination of accounts.

Here's the rest of what you need to know about RMDs and avoiding the penalty for failing to take them:

Initial year required minimum distribution

For the year you turn 70½ and for every year thereafter, you must take an annual RMD as long as you have any traditional IRA balances.

The initial RMD for the year you turn 70½ can be taken as late as April 1 of the following year. Alternatively, you can take it by Dec. 31 of the year you turn the magic age. Then for each subsequent year, you must take another RMD by no later than Dec. 31 of that year.

If you turn 70½ this year, there is a good reason to consider taking your initial RMD by the end of this year rather than taking it next year by the April 1 deadline. Post continues after video.

Consider the following example: You turn 70½ in 2011. You decide to put off taking your initial RMD until next year. That puts you in the double-dip RMD mode for 2012.

You must take your initial RMD by no later than April 1, 2012 (that one is actually for 2011, the year you turned 70½). Then you must take your second RMD by Dec. 31, 2012 (that one is for 2012). If you have lots of IRA money, falling into the double-dip mode could push you into a higher tax bracket.

For instance, say your IRA balance is $500,000, thanks to money rolled over from employer retirement plans. Being in the double-dip mode for 2012 would force you to take two RMDs totaling about $36,000 next year. If you instead take your first RMD in 2011 and the second one in 2012, the RMD for each year would be about $18,000, and you might pay a lower tax rate.

Waiting until next year could also cause you to fall victim to various unfavorable rules that kick in at higher income levels. For instance, it could cause a higher percentage of your 2012 Social Security benefits to be taxable.

Bottom line: If you have lots of IRA money, you may be better off taking your initial RMD this year, even though that will trigger some taxable income that could otherwise be deferred until 2012. On the other hand, if you don't have so much, waiting until next year is usually the right choice.

How to calculate RMDs

The RMD amount for a particular year equals the combined balance of all your traditional IRAs (including any SEP or Simple IRA accounts) as of the end of the previous year divided by a joint life expectancy figure found in IRS tables. As you get older, the life expectancy divisor becomes smaller, and the annual RMD amount becomes a higher percentage of your IRA balance.

The joint life expectancy divisor is based on your age and the age of a beneficiary who is automatically assumed to be 10 years younger. This rule applies even if you have no beneficiary or if the beneficiary is actually older than you.

The only exception to the rule is when your spouse is designated as the sole IRA beneficiary and he or she is more than 10 years younger. In this circumstance, you're allowed to calculate RMDs using more favorable joint life expectancy figures based on the actual ages of you and your spouse.

The most important thing to understand is that IRA owners who have reached 70½ cannot afford to ignore the RMD rules. The 50% penalty for noncompliance is too expensive. If you turn 70½ this year, the other important thing to understand is you have an RMD choice to make before the end of the year. If you sit on your hands, you will be in the RMD double-dip mode next year, which might result in a higher tax rate that could have been easily avoided.

More on SmartMoney and MSN Money:

• How to tap retirement funds responsibly
• Don't play dead with your rollover
• How to avoid costly tax penalties
• Calculator:Am I saving enough for retirement?
• How much money will my 401k provide?
• 5 investing rules for retirement