When you withdraw money from your IRA (or if you inherited an Individual Retirement Account from someone and you take yearly distributions), don’t fool yourself.
Just because you withdraw money from a retirement account does not mean that you actually made that money. Rather, you might just be pulling out your principal. Here’s how to tell the difference and why it matters:
Since I work with American citizens living in Israel who have retirement accounts in the States, I will use an example that I see a lot: Once an American turns 70½ years old, if he has money in a traditional IRA, he must begin to take “required minimum distributions.” That simply means he needs to take out a certain amount of money every year. The IRS mandates this withdrawal because they have never earned any taxes off this money and they want to make sure they get some tax revenue before the person dies.
Example of IRA distribution
Let’s say a $500,000 portfolio is invested in cash in an IRA account that earns 0%. If the required distribution is $10,000, someone might withdraw that money and spend it as though it is income. It’s true that he will be taxed on the withdrawal as if it were income, but he did not actually make any money in an IRA from the investment. Rather, he just took out principal.
Can you actually invest money and make money in an IRA?
Instead of making almost 0%, he could have invested the money through a “self-directed” Individual Retirement Account. Had he chosen simply to buy certificates of deposit (CDs) in the bank, and if he made 2% on them, the $10,000 distribution would have actually been money that he earned from his investments rather than drawing down his principal. Doesn’t that sound like a better deal?
If you’d like to find out about buying FDIC insured CDs (Certificates of Deposit) while you live in Israel, or have questions about your IRA account, feel free to call my office at 02-624-2788 or send me an email at doug@profile-financial.com.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published July 27, 2018.