If you’re turning age 70 this year, you have a lot of company. You will be joining 2.5 million Baby Boomers, including Elton John, Glenn Close, and David Letterman. Turning 70 is not only a milestone to celebrate, it can also have financial consequences that you should be aware of.
Age 70 is an important marker in terms of your Social Security benefits. Although you can claim Social Security benefits as early as age 62, your benefits will be lower for your lifetime. The rule of thumb is that for every year that you wait to trigger Social Security, your benefits will increase by about 8% per year. However, once you turn 70 your benefits max out, so there’s no advantage to wait any longer — you’ll just be passing up money you’re entitled to. Contact your Social Security office a few months before you turn 70.
A closely-associated milestone is age 70 ½. This is the age at which you must begin taking annual Required Minimum Distributions (RMDs) from your retirement accounts, like Individual Retirement Accounts (IRAs), 401(k)s, 403(b)s, and 457 Deferred Compensation accounts. The IRS has many penalties for not complying with their rules, but the one governing RMDs is one of the most severe — if you don’t take your RMD like you’re supposed to, the IRS can penalize you 50% on what you should have taken out. For instance, if you fail to take your Required Minimum Distribution of $10,000, the IRS can fine you $5,000.
The way to calculate your RMD is straightforward. For example, if you’re turning 70 ½ this year, take the value of your retirement account on December 31, 2016 and divide it by 27.4. Therefore, at age 70 ½, your RMD will be about 4%. If your IRA was worth $500,000 on 12/31/2016, and you’re turning 70 ½ this year, your RMD would be $18,248.
Each year, the amount will be different because your retirement account may have grown, and the denominator changes based on your age. Your Certified Financial Planner should be able to calculate your RMD for you each year, and make sure you receive it on time.
The very first year you take an RMD, the rules offer a little flexibility. You can delay taking your first RMD to April 1 of the year following the one in which you turned 70 ½ . However, it also means in that year, you will have to take two RMDs. This sometimes makes sense. When you retire, some companies pay out all your accrued vacation and sick time. This, combined with receiving your RMD, could push you into a higher tax bracket. Even if you have to take two RMDs next year, it could help to even out your tax liability.
Many people think that once they turn 70 ½ and they have to start taking RMDs, the value of their retirement accounts will fall every year and eventually go to zero. However, this doesn’t have to happen. If you have your retirement accounts in a globally-diversified, balanced portfolio, it’s not unusual to have the average growth of your account exceed 4 or 5% per year. Even after you start taking RMDs, your accounts can continue to grow. Consequently, you can not only enjoy some money from your IRAs each year, but also pass on what’s left to children and grandchildren in Inherited IRAs after you’re gone.
By the time you get to age 70, you may have accumulated a number of retirement accounts over a lifetime of work. When you turn 70 ½ you can take the correct RMD from each one of these accounts, but as long as the total RMD amount is correct, you can take it from any of your retirement accounts — the IRS doesn’t care. Therefore, it makes sense to take the total RMD from the retirement account that is growing the slowest, preserving the retirement account that is growing really well.
Some people have Required Minimum Distributions so large that they need to plan ahead regarding tax withholding. The assets in your retirement accounts represent money that has never been taxed before, so any distribution you take is taxed at ordinary income rates, just like you had extra working income that year. Federal and State tax withholding is optional on Required Minimum Distributions. However, if you are paying Quarterly Estimated Taxes and then receive a substantial RMD at the end of the year without any tax withholding, you could face an underpayment penalty from the IRS. You can avoid surprises at the end of the year by having the taxes withheld.
There’s one important exception to the Required Minimum Distribution rule. If you’re still working after age 70 ½ (and you don’t own 5% or more of the company), and you have a 401(k) at the firm, you don’t have to take an RMD from the 401(k) until the year you stop working. You will still need to take RMDs from your other retirement accounts.