Most people don’t know the rules about required minimum distributions, which fix how long a beneficiary can stall on paying income taxes on a retirement plan. Also known as “RMDs,” these are the rules that require investors to make withdrawals from their retirement accounts the year that they turn 70½. However, says Forbes in the article “5 Things to Know About RMDs,” these withdrawals can have a major impact on cash flow, taxes, and financial planning during retirement. They are legally required to be taken, even if you don’t need them.
If the RMD is not taken at the correct age, there will be a 50% tax on the amount that should have been withdrawn. Add to that the amount of regular income tax on the sum of money withdrawn, and you have an expensive mistake.
There are ways to soften the impact of RMDs. However, you have to know the rules before you can create your strategy. Having a game plan for RMDs will help protect the money you saved for many years and allow that retirement nest egg more time to grow.
Note that there may be some changes coming as a result of the SECURE Act and the RESA Act, if approved. See my blog on this coming Wednesday.
Distribution rules that you need to know. The year you mark your 70½ birthday, that is, six months after you turn 70, you have to start taking RMDs from retirement accounts, including 401(k)s. That rule does not apply to Roth IRAs, which generally do not have any RMDs, until the owner dies.
The exception is if you are still working at a company and participating in the company’s 401(k) plan. If that is the case, you may want to roll over all your previous eligible savings into that account, to delay taking an RMD. However, there are also exceptions to this rule. They depend on your ownership stake in the company, so speak with an estate planning attorney to be sure what the requirements are for your situation.
While you’re at it, make sure that the beneficiaries listed on your accounts are correctly documented. If it’s been more than a few years since you last reviewed your beneficiaries, there may be some time bombs hidden in your IRA accounts. Divorce, death, and changes of circumstances may make it necessary for you to change your beneficiaries. Do it now, while it’s on your mind. Once you die, there’s no recourse for your heirs.
When do I take my first RMD? RMDs must be taken by December 31st of each calendar year. However, the first RMD must be taken for the year in which you turn 70½. You can delay that payment until April of the following year. If you end up taking two big distributions, will it throw your tax planning off? Will you be bumped into a higher tax bracket? This is why you need to plan your RMD payout carefully. It may be better for your overall situation to take the RMD as soon as you are eligible.
Accuracy counts. You can’t rely on an online calculator since the rules are not one size fits all. Let’s say your spouse is ten years younger than you and is your sole beneficiary. You’ll need to use the Joint Life and Last Survivor Table. There’s also the Uniform Lifetime Table, but that doesn’t apply here. Check with professionals to be sure you are taking the right amount.
Where does your RMD come from? Even if 70½ is a few years away, it’s good to have a plan for how RMDs will impact the distribution of your investment portfolio. You have options, so you want to make a good choice. For example, do you want distributions to be made in proportion to the percentage of each of your holdings in your portfolio? Let’s say 40% of your retirement investment is in short-term bonds, then you would take out 40% from your investment holdings. Or do you want to take a percentage from specific holdings?
What about charitable giving? Once you turn 70 ½, you can directly transfer funds from a traditional IRA to a charity, which can reduce your tax burden. However, this must be done properly, directly to the charity.
The rules of RMD are complicated, and mistakes can be expensive. Think about your strategy early on to make sure it’s done right.
Reference: Forbes (May 14, 2019) “5 Things to Know About RMDs”