dollars in an Uncle Sam hatAfter a year's reprieve, if you are more than 70 1/2 in 2010, you have to ante up a required minimum distribution (RMD) from your IRA, 401(k) or 403(b) and pay Uncle Sam his due.You'll also owe an RMD if you inherited a taxable IRA, no matter what your age.

Last year, because even Uncle realized we were all in dire financial straights, we got a break, but not this year. Anybody born before July 1, 1939, with a tax-advantaged retirement account must withdraw the amount equal to the total balance of your retirement accounts as of Dec. 31, 2009, divided by the distribution period of your life expectancy. You must figure out what the IRS considers your life expectancy by using these tables.

Failure to pay on time comes with expensive consequences – a 50% penalty on the shortfall.

There are a few things you can do to mitigate the pain, says Rebecca Pavese, a certified public accountant and manager of Palisades Hudson Financial Group's national tax practice in Atlanta:

  • If you have loser stocks, take those out of your IRA and sell them. You're probably going to do it anyway, and you can take the loses against gains in taxable accounts.
  • If you have stock that you're hopeful will eventually have big gains, Pavese suggests that you take the distribution as securities rather than cash. Tell your custodian to move the requisite number of shares into a taxable account. Pay the required tax with other cash and let the shares appreciate. When you finally sell them -- provided you have held them for a year -- you'll pay the capital gains rate, which even if the government raises in the years ahead, will be lower than the ordinary income tax rates you'd pay if you left the gain in your IRA.
  • Withhold money from your IRA to pay your income taxes. If you pay quarterly estimated federal income taxes on other income, you can direct your plan custodian to withhold your income taxes from your RMD distribution. For instance, let's say you owe $10,000 in 2010 tax. Normally, you'd have to make four payments of $2,500 throughout the year, but if you must make a $10,000 RMD, you can have the custodian withhold $10,000 in tax from your IRA, in effect your RMD. Because the custodian is withholding the money, it can all come out of the IRA at the end instead of throughout the year -- and you won't pay a penalty for underpayment of estimated tax. That way you get to invest your money longer, Pavese points out.

This is also a good year to consider converting a regular IRA or 401(k) to the Roth version. The 401(k) conversion option is new -- Bankrate.com tax expert Kay Bell offers a thorough explanation. Rick Rodgers, a financial planner and author of a new book on retirement, The New Three-Legged Stool, adds that any Roth conversion that is done in 2010 doesn't have to be reported on your 2010 return. You can report that income on your 2011 and 2012 returns.

For example, if you converted $100,000 in 2010, you would report $50,000 in income in 2011 and $50,000 in 2012. But if you wait to do the conversion after 2010, you have to declare the income in the year you convert and pay it all at once. To get this tax deal, you've got to do the conversion by Dec. 31. If you wait until 2011, you'll owe the whole tax in your 2011 tax bill.


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