If you are approaching retirement you have, no doubt, heard of RMDs. Failure to understand how the IRS recognizes and treats RMDs can result in penalties to the tune of 50%. Most of us haven’t spent all of our working years saving and investing just to pay a penalty to the IRS to access our own money. Knowing the rules and regulations on when and how to take your RMDs can save you money (& heartburn) in retirement.
RMDs are Required Minimum Distributions. After all the years the IRS has allowed taxpayers to defer taxes on contributions to and earnings within IRAs and company sponsored retirement plans such as 401k’s, 403b’s, Thrift Savings Plans and others, they finally want to collect some taxes. RMDs are the method the IRS uses to start collecting taxes on retirement assets.
The magic age when investors MUST begin making Required Minimum Distributions is 70 ½; not 70, not 71, but 70 ½. And the IRS has specific guidelines on when to take the distributions and how much to take for your distributions.
Your first distribution must be taken by April 1 of the year after you turn 70 ½. For all subsequent years, distributions must be taken by December 31. For example, if your birthday is December 10, 1947, you will turn 70 in December 2017. You will turn 70 ½ in June 2018.
* Your first RMD must be taken by April 1, 2019
* Your second RMD must be taken by December 31, 2019
* Your third RMD must be taken by December 31, 2020
* And all future distributions must be taken by December 31 of each subsequent year
The amount of your distribution is based on the value of your retirement account as of December 31 of the previous year. Using the example above, if you turned 70 on December 10, 2017; you would use the following year end values to determine your RMD:
* Your first RMD will be based on the value of your account on December 31, 2017
* Your second RMD will be based on the value of your account on December 31, 2018
* Your third RMD will be based on the value of your account on December 31, 2019
* And so on
To determine the distribution amount, the year-end value is divided by a factor based on your current age. This factor changes every year, but is published by the IRS as the Uniform Lifetime Table III. All financial institutions use this formula and the IRS Table to calculate Required Minimum Distributions.
The IRS requires each company sponsored retirement plan to fulfill RMD requirements. If you have three 401ks when you reach age 70 ½, you will be required to receive three separate RMDs, one from each retirement plan. If you have three IRAs when you reach age 70 ½, you can sum the total value of all three IRAs and choose to take a single RMD from one of the IRAs and as long as the single RMD equals the total RMDs required from each IRA, the IRS will allow you to take a single RMD. If you have multiple 401ks and multiple IRAs, you must take a separate RMD from each 401k, but you have the option of taking a single RMD from one of the IRAs to satisfy the IRA RMD requirements. Confused yet?
Each RMD is taxed as ordinary income, just like your paychecks were. If you fail to take an RMD on the timeline outlined above, in addition to the ordinary income tax, the IRS will charge you a 50% penalty. Needless to say, understanding when and how to take your Required Minimum Distributions is serious business.
One final note on RMDs. If you are still working past age 70 ½ and have an active company sponsored retirement plan like a 401k, you are not required to take any RMDs from that plan. But, if, while you’re working, you have any old 401ks or current IRAs, you are still required to take RMDs from those accounts.
Many investors have determined that it makes sense to rollover (a tax free process) their old 401ks and other company sponsored retirement plans (403b, TSP, etc.) to a single IRA. This simplifies the management of RMDs and helps minimize the possibility of making an RMD mistake.
As you inch closer to your retirement years, be sure to understand what your RMDs mean to you.