The first of the baby boom generation will be required to start taking RMDs from their retirement accounts this year. The generation that lived through and influenced the revolution in the retirement industry is now poised to begin withdrawing money from their retirement-saving vehicles — namely IRAs and/or employer-sponsored retirement plans such as 401(k)s.
If you were born in the first half of 1946 — you are among the first baby boomers who will turn 70½ this year. That’s the magic age at which the Internal Revenue Service requires individuals to begin tapping their qualified retirement savings accounts. While first-timers officially have until April 1 of the following year to take their first annual required minimum distribution (RMD), doing so means you’ll have to take two distributions in 2017. Taking two RMDs in one year could potentially push you into a higher tax bracket.
This is just one of the tricky details you’ll have to navigate as you enter the “distribution” phase of your investing life. Here are five more RMD considerations that you may want to discuss with your CPA or Certified Financial Planner™.
RMD rules differ depending on the type of account
For all non-Roth IRAs, including traditional IRAs, SEP IRAs, and SIMPLE IRAs, RMDs must be taken by December 31 each year whether you have retired or not. (The exception is the first year, described above). For defined contribution plans, including 401(k)s and 403(b)s, you can defer taking RMDs if you are still working when you reach age 70½, provided your employer’s plan allows you to do so AND you do not own more than 5% of the company that sponsors the plan.
You can craft your own withdrawal strategy
If you have more than one of the same type of retirement account — such as multiple traditional IRAs — you can either take individual RMDs from each account or aggregate your total account values and withdraw the total annual RMD amount required from a singular account. As long as your total RMD value is withdrawn, you will have satisfied the IRS requirement. Note that the same rule does not apply to defined contribution plans. If you have more than one 401(k), for example, you must calculate separate RMDs for each account, then withdraw the appropriate amount from each.
Taxes are still due upon withdrawal
You will probably face a full or partial tax bite for your IRA distributions, depending on whether your IRA was funded with nondeductible contributions. Note that it is up to you — not the IRS or the IRA custodian — to keep a record of which contributions may have been nondeductible. For defined contribution plans, which are generally funded with pretax money, you’ll likely be taxed on the entire distribution at your income tax rate since this is money that has never been taxed before. Keep in mind that the amount you are required to withdraw could possibly bump you up into a higher tax bracket.
Penalties for noncompliance can be severe
If you fail to take your full RMD by the December 31 deadline on a given year or if you miscalculate the amount of the RMD and withdraw too little, the IRS may assess an excise tax of up to 50% on the amount you should have withdrawn — and you’ll still have to take the distribution. Note that there are certain situations in which the IRS may waive this penalty. For instance, if you were involved in a natural disaster or became seriously ill at the time the RMD was due, the IRS might be willing to cut you a break. To request the excise tax waiver, you’ll need to file IRS Form 5329 with your annual tax filing – and a brief but specific letter of explanation might help. If the IRS does not honor your waiver request, you will be notified.
Roth accounts are exempt
If you own a Roth IRA, you don’t need to take an RMD. If, however, you own a Roth 401(k) the same RMD rules apply as for non-Roth 401(k)s, the difference being that distributions from the Roth account will be tax free. One way to avoid having to take RMDs from a Roth 401(k) is to roll the balance over into a Roth IRA.
For More Information
Additional information about retirement account RMDs can be found in IRS Publication 590-B, including the life expectancy tables you’ll need to figure out your RMD amount.
Navigating your Required Minimum Distribution for the first time can be tricky, so get in touch with your Certified Financial Planner™ or CPA well before year-end and create a plan that works for your individual circumstances. Your financial and tax professionals can help you determine your RMD amount and advise you what to do with the proceeds. You may choose a simple transfer of funds from a pre-tax account to an after-tax account for continued growth of investment portfolio. However, perhaps those proceeds could help to fund an overdue vacation. Paying taxes on RMDs is no fun, but when life gives you lemons….
The information in this communication is not intended to be tax advice. Each individual’s tax situation is different. You should consult with your tax professional to discuss your personal situation.