Most retired folks know that IRS rules require owners of retirement accounts to take distribution when they reach a certain age. It’s called the Required Minimum Distribution or RMD. But sometimes people get some of the details wrong. So here are a few things to remember about RMDs
Getting the RMD wrong can sting
If you don’t take out the required amount by the deadline, the penalty is 50 percent of the amount you should have withdrawn. That’s on top of the required distribution and state and federal income tax. Your IRA could take a heck of a wallop if you make this simple mistake.
It’s not just IRAs that apply. RMD rules apply to these types of retirement accounts:
- 401(k) plans
- 403(b) plans
- Profit sharing plans
- 457(b) plans
- Traditional IRAs
- SEP IRAs
- SARSEPs
- SIMPLE IR
You do not have to take a distribution from your Roth IRA — ever.
Inherited accounts are different
If you inherit an IRA, and the deceased owner of the IRA had started taking required distributions before death, then you most likely need to take distributions. A detailed IRS chart is here. But generally,
- Spouses have more choices
- Non-spouse persons have other choices
- Non-persons, no beneficiary, charities and trusts have still other choices
- Inherited Roth IRAs are subject to standard RMD rules and penalties
Don’t miss the deadline
The first distribution must come after you turn age 70½:
- If your birthday falls between January and June, you’ll turn 70½ in the same year as your 70th birthday.
- If your birthday is between July 1 and year end, then you won’t turn 70½ until the next calendar year.
In the first year, you can delay the distribution until April 1 in the calendar year following the year you turn 70½. But if you do, you will need to take another distribution by December 31 of the same year.
Carefully consider the cost of delaying the first RMD
If you do wait until April 1 of the year after you turn 70½ to take your first RMD, remember that since you need to take the next RMD by year end, you will have two RMDs in your income for that year.
For example, if your IRA is valued at $500,000 on December 31, 2017 and you turned 70 on January 1, 2018, your required minimum distribution would be $18,249. Two of those equals $36,498.
Adding $36,000 or $37,000 to your income could bump you into a higher tax bracket.
- You would pay tax at a higher rate on some of your income.
- You might be subject to the Medicare high-income surcharge if your adjusted gross income (plus tax-exempt interest income) rises above $85,000 if you’re single or $170,000 if married filing jointly.
- The extra income could also cause a larger portion of your Social Security benefits to be subject to taxes.
Get the amount right
To calculate your required distribution for each year, you start with the account balance as of December 31 of the prior year. You divide that amount by the factor on the Uniform Lifetime table (Table III) in Appendix B of IRS Publication 590-B. You can also use an RMD calculator to figure out the amount.
Take note: If your spouse is your sole beneficiary and is more than 10 years younger than you, you use Table II, the Joint Life and Last Survivor table. And if you inherited an IRA, you should probably use Table I. Consult your Certified Financial Planner™ professional for the details of your situation.
Remember that 401(k)s are different
I generally advise that clients roll 401(k) accounts over into IRAs at retirement for several reasons. But if you still have money in a 401(k) at age 70, the way you make required distributions is different.
With IRAs, you can total all the IRAs together and make a distribution from one account to satisfy the minimum.
With 401(k)s, you must take a distribution from every account separately.
Don’t forget to take distributions from Roth 401(k)s
Even though you don’t have to take RMDs from Roth IRAs, you must take them from Roth 401(k)s. The withdrawals from the Roth 401(k)s won’t be taxable, but you still need to take out the required amount each year (unless you’re still working for that employer).
The rules are different if you’re working
As long as you don’t own more than 5 percent of the company, you usually don’t have to take RMDs from your current employer’s 401(k) while you’re still employed. But you do need to take RMDs from previous employers’ 401(k)s and from your traditional IRAs at 70½, even if you’re working.
You can’t avoid your RMD by converting your IRA to a Roth IRA
When you convert a traditional IRA to a Roth IRA you must pay tax on all the money converted. But the required distribution is actually based on balances in the past. So the RMD is still required. The RMD money needs to leave the IRA environment. The balance can be converted and go forward as a Roth IRA.
Don’t mess up a tax-free transfer from the IRA to charity
After you turn 70½, you can give up to $100,000 tax-free from your traditional IRA to charity each year. The gift counts as your RMD but isn’t included in your adjusted gross income —giving you a chance to receive a tax benefit for your charitable gift, even if you don’t itemize. But you can’t make a tax-free transfer and take the charitable deduction for the same money.
However, you must transfer the money directly from your IRA to the charity for it to stay out of your AGI. So do not withdraw the money first and then write a check to the charity. The procedures to make the transfer vary by IRA custodian, so check with your CFP® professional for the details of your situation.
Don’t forget your investment allocation
Some IRA or 401(k) administrators automatically take the RMD money pro rata from each of your investments unless you specify otherwise. This might not be the best idea for your situation. If you are working with a CFP® professional, they will make sure that your account has cash on hand when you need to make your annual distribution and that the rest of your investments are positioned to best meet your financial goals.
IRS resources
Every situation is different, so it pays to work with your own advisor. But if you want to do some leg work on your own, the IRS has a great set of frequently asked questions here.
I’m a big believer in the value of professional advice. With a 50 percent penalty, it’s cheap insurance to consult with your own financial planner to get your situation right. I suggest you set a meeting with a CERTIFIED FINANCIAL PLANNER™ professional.
If you meet with a planner who is always an advocate for the client– a fiduciary advisor – and only works for the client – a fee-only advisor – you can be confident that the financial advice you get is focused on your best interests and is a good fit for your complete situation.
CFP® professionals take a multi-faceted approach to your financial planning process that includes budgets, risk protection, retirement planning, investment management, taxes and estate planning. All these related aspects of your financial life are what really matter when it comes to reaching your goals.
A CFP® professional can help you create a financial plan that is driven by your goals and priorities and addresses all aspects of your financial life. With a big-picture approach, you will be better prepared in the event that you have to leave work earlier than you expected.
Yes, I am a CFP® professional. I’m always a fiduciary and I only work on a fee basis. And yes, I’m still taking on a few great families to be part of my financial planning practice.
If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their financial plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.