Required minimum distributions (RMDs) are often a source of confusion among retirees and the penalties for not taking them are hefty. RMDs are when Uncle Sam "makes" you take money out of your retirement accounts. This begins at age 70 ½ and continues every year for the rest of your life (or until your retirement accounts are depleted). Here are a few things that you need to know about RMDs.
The Nuts and Bolts
RMDs must be taken on all retirement accounts including Traditional IRAs and company-sponsored retirement plans like 401(k)s once you reach age 70 ½.
Based upon IRS tables, the amount in your retirement plans such as IRAs, 401(k)s, etc. at the end of the year are divided by the factor on the appropriate table for your age. For most of us, the first year RMD will be the prior year’s account balance at December 31 divided by 27.4. For example, if your balance was $274,000, this balance would be divided by 27.4 years resulting in a first-year RMD of $10,000.
No matter how great your investments perform, you'll eventually notice your retirement account balances going down just because the percentage you're required to withdraw increases every year. You can decide what you want to do with the money withdrawn from your IRA (i.e. spend it or even reinvest it in a non-retirement investment account). You just can't deposit it back into a retirement account.
If you fail to take your RMD, you'll get slapped with one of the IRS' steepest penalties - 50% of the amount that was required PLUS the tax that would have been due (Ouch!).
Penalties also apply on any portion not taken. For example, if your RMD should have been $20,000 and you only took $10,000 then the penalty would apply to the $10,000 not taken.
Don't Make A Timing Mistake
Your first required minimum distribution will be for the year in which you turn 70 ½. For example, if you turn 70 on January 1, you turned 70 ½ on July 1 and you would have a required distribution for the current calendar year, 2017. If your birthday is September 1 however, your first distribution is not required until 2018 since that’s when you turn 70 ½.
For your first RMD only, you are not required to take the distribution until April 1 of the calendar year following the year in which you turn 70 ½. All subsequent RMDs must be taken by December 31 of the appropriate year. Delaying the first-year distribution until April 1 of the following calendar year would mean that you would be taking two distributions in the same calendar year and paying tax on both for the same calendar year.
Confused yet? Here's a chart that might simplify things:
|Date of 70th Birthday||Latest Date First RMD can be Taken||Latest Date Second Year RMD can be Taken|
|January 1- June 30, 2017||April 1, 2018||December 31, 2018|
|July 1- December 31, 2017||April 1, 2019||December 31, 2019|
Often for this reason I suggest taking the first distribution in the year that it applies. For example, in the case of the person whose 70th birthday is January 1, 2017, I’d generally suggest they take their 2017 RMD by December 31, 2017 and their second RMD by December 31, 2018. That said there are situations where waiting until the following year and taking both distributions in the same calendar year can make sense based upon your situation.
Which Accounts Apply?
Generally speaking, RMDs are due on all retirement accounts except Roth accounts. If you have three IRAs you have the option of calculating the RMD for each and taking it from each account. Or you can take the combined distribution from a single account or any combination of them.
* If you have an old employer-sponsored retirement plan like a 401(k) or 403(b), the RMD for each of these accounts must be taken separately.
If you’re age 70 ½ or older and still working, you may be able to delay taking RMDs from your employer-sponsored retirement plan using the 'still working exception'. For this exception to apply you must:
- Be considered employed throughout the entire year
- Own no more than 5% of the company
- Participate in a plan that allows you to delay RMDs
What about Roth IRAs and Roth 401(k)s?
Assuming several conditions are met, there are no RMDs for a Roth IRA account. This also includes a Roth IRA that is inherited by a spouse.
RMDs are required from a Roth IRA account inherited by a non-spousal beneficiary (such as children, grandchildren, etc.). The distribution is free from tax, however.
Read closely...because this is a rule that most folks don't realize. Roth 401(k) accounts also require that you take an RMD if you have left the company. Often your best bet here is to roll the Roth 401(k) account to a Roth IRA to avoid the RMD requirement.
What if I Inherited an IRA?
If you inherit an IRA from someone other than your spouse, you will be required to take RMDs.
If the deceased account owner was already taking RMDs when they died then you will be required to continue taking them. Assuming this person was older than you, the advantage here is that you can take the RMD based on your life expectancy which is longer than theirs. This means that the amount of the distribution will lower allowing you to stretch the tax-deferred nature of the account out for a longer period of time.
If the original account owner was not taking RMDs when they died then you can wait to take them until you reach age 70 ½.
In either case, the RMD from this account is separate and distinct from any other retirement account. Here's a beneficiary RMD calculator to help.
Qualified Charitable Distributions
A couple of years ago, Congress made the rule permanent allowing those who are at least 70 ½ to use up to $100,000/year of their RMD as a charitable contribution (known as a Qualified Charitable Distribution or QCD).
To qualify as a QCD, the rules stipulate that the distribution must go to a public charity, and thus cannot go to a private foundation or a donor-advised fund. The advantage is that this amount is not included in your taxable income. *Note that you will not receive a charitable deduction for this amount as well.
RMDs can be Complicated
Leave it to the IRS tax code to make things complicated. Required minimum distributions can be tricky and the penalties for not taking them (or for not taking the right amount) are steep. I can help you manage this process. Please feel free to give me a call at (785) 256-9150 or schedule a FREE initial consultation.
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Desmond Henry is a fee-only CERTIFIED FINANCIAL PLANNER™ professional and founder of Afflora Financial Life Planning in Topeka, Kansas. He helps the retiring/retired plan their finances and invest their money. CLICK HERE to learn more.