Tax deferral in a retirement account is a delay rather than a permanent exemption. Federal law sets a point at which withdrawals must begin and continue annually.
Deferral has an endpoint written into law
Contributions to traditional retirement accounts generally reduce taxable income in the year made, and investment growth is untaxed while it remains inside the account.
The arrangement postpones tax until distribution, and the required distribution rules exist so that postponement does not continue for an unlimited period.
The starting age has been changed by legislation more than once in recent years, so the applicable age depends on the account holder's birth year and current law.
The amount comes from a division
Each year's required amount is calculated by dividing the prior year end account balance by a life expectancy factor published in federal tables.
The factor declines as the account holder ages, so the fraction of the account that must be withdrawn rises each year even if the balance stays flat.
A separate table applies where a spouse who is significantly younger is the sole beneficiary, which produces a smaller required amount.
Account types are treated differently
Traditional individual retirement accounts and most employer plan balances are subject to the rules, and the calculation is made for each account.
Aggregation rules differ by account type: amounts from several individual retirement accounts may be combined and taken from one, while employer plans generally require separate withdrawals.
Roth accounts follow different rules during the owner's lifetime, and the treatment of inherited accounts is a separate framework that was substantially revised by recent legislation.
The consequence of missing one is specific
Failing to take a required amount triggers an excise tax on the shortfall, with a reduced rate available in defined circumstances where the failure is corrected promptly.
Relief procedures exist for reasonable errors, and they involve filing specific forms and providing an explanation to the tax authority.
Because the amounts and the correction procedures are set by statute and revised periodically, current requirements should be verified rather than assumed from memory.
The requirement is a withdrawal, not a sale
The rule requires that money leave the tax deferred account. It does not require that investments be sold, since securities can be distributed in kind to a taxable account.
Distributed amounts generally enter taxable income for the year, which can interact with other calculations that use income thresholds.
These interactions are individual and depend on the full return, so a tax professional rather than a general explanation is the appropriate source for a specific situation.