As it is the fourth quarter of the year, it is time for senior investors, ages 71 and older, to focus on their required minimum distributions (RMDs) that must be completed by December 31.
If you have a tax-deferred retirement account, the IRS requires you to withdraw a minimum amount once you reach age 70 ½. RMDs are required from traditional, rollover and inherited IRAs, Simplified Employee Pension, SIMPLE plans as well as qualified retirement plans, such as a Keogh, Individual 401(k) and 403(b). The mandatory distribution rules also apply to Roth 401(k) accounts; however, they do not apply to Roth IRAs while the owner is alive. Basically, the government has allowed your assets to grow tax-deferred over your lifetime, and now it is time to pay income tax on those assets.
The first required minimum distribution must be made from your individual retirement accounts by April 1, following the year you reach age 70 ½, regardless of whether you are retired. Distributions must then be taken each subsequent year by Dec. 31st. While the basic rules sound pretty cut and dry, there are a considerable amount of circumstances that need to be considered for an investor when it comes to RMDs—most importantly, the timing of when the withdrawal must be taken, how much needs to be withdrawn and fully understanding the tax consequences of the withdrawal, as a substantial withdrawal can bump you into a higher tax bracket.
If you do not withdraw the minimum amount required by the deadline, you will be assessed a penalty on Excess Accumulation, an insufficient distribution, which is 50% of the shortfall. If your RMD is $2,000 and you only withdraw $1,000 by the deadline, you will be penalized $500 on the $1,000 not taken. However, most retirees face RMDs of $50,000 or more. Miscalculating an RMD by several thousand dollars can result in a meaningful loss of retirement dollars to the penalty.
Quite often, senior investors have several IRAs, multiple 401(k) plans from previous employers, pensions, Social Security and other income. Even if you are already drawing from one of your accounts, the RMD rules may increase your required withdrawal. If you don’t need the money to cover your living expenses, it can be easy to overlook old accounts. The required withdrawal is the value of your accounts at the end of the previous year divided by a life expectancy factor published in IRS tables. RMDs must be calculated separately for each IRA held, but the total withdrawal can be taken from one account. Qualified retirement plans work differently. RMDs from Keoghs, Individual 401(k) accounts, or Inherited IRAs must be calculated separately and must be taken from each individual account.
The only exception to the RMD rules is if you are still working for the company and participating in the 401(k). Providing you are not more than a 5% owner in the company, you may be able to delay the RMD until after you retire. The IRS leaves the decision up to the company.
Furthermore, RMDs are not all or nothing. You can divvy up your mandatory withdrawal, using some of it for living expenses, transfer holdings to a taxable account, gifting money to a 529 Plan, make a qualified charitable distribution or convert the funds to a Roth IRA. Each option has its own tax advantages.
By working with a financial adviser, you can put your RMD to work for you. A financial adviser can work closely with you and your tax adviser to minimize your tax liability and help you avoid unnecessary penalties. If you have questions regarding your required minimum distributions, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
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