Did you know that 2.1 million baby boomers will celebrate their 70th birthday this year? This fact is relevant because the Internal Revenue Service (IRS) instructs that such individuals begin taking Required Minimum Distributions (RMD) from their retirement plans at the age of 70½. These are the notorious Required Minimum Distribution Rules (RMD)
It is important that you understand the rules with respect to RMDs, otherwise, you could get hit with the 50% tax penalty for noncompliance. Realistically speaking, if you are among the 74 million boomers age 52 to 69, you’ll want to educate yourself on how Required Minimum Distribution rules work as well. After all, your time will come soon enough.
What in the World are RMDs?
Upon entering the ripe age of 70½, the IRS requires you to withdraw a specified amount of money from certain retirement accounts annually. This is done to ensure that the government receives tax revenue from tax-sheltered retirement accounts.
The accounts subject to the Required Minimum Distribution Rules set by the IRS include:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- Inherited IRAs
- Rollover IRAs
- 401(k), 403(b) and 457(b)s
- Keogh Plans
Roth IRAs do not require withdrawals until after the death of the owner. However, RMD rules do apply to Roth 401(k)s.
When You Must Take Your RMD
Given the fact that Required Minimum Distribution rules are essentially tax rules, it should not be surprising that the designated time for making your first Required Minimum Distribution is rather complicated.
However, waiting until April 1st of the year after turning 70½ will lead to you taking two distributions in the same year, which could move you to a higher tax bracket causing an increase in taxes due.
According to Charles Schwab, which offers an excellent free online guide to the Required Minimum Distribution Rules, there is one notable exception to the rules for RMDs. You are able to delay your RMD from a 401(k) until retirement if you are 70 or older, continue to work, and do not own more than 5% of the company that you work for.
The Amount you Must Withdraw
The amount of your Required Minimum Distribution (RMD) is determined by your retirement account(s) balance(s) and the IRS’s estimates for life expectancy.
If you are among those turning 70½ this year, you will need to calculate the total balance of all of your RMD-eligible accounts, and then divide that total by the IRS’s figure of 27.4. For example, suppose you have $300,000 in traditional IRAs. You would need to withdraw $10,949, which is $300,000 divided by 27.4.
An exception to this rule is the IRS’s “joint life expectancy” method, which results in a lesser RMD. This scenario exists when you’re married and your spouse is greater than 10 years younger than you and will be your sole beneficiary.
A free online RMD calculator is available on Kiplinger’s, as well as on most other major financial-service company websites.
The financial institution holding your IRA will most likely alert you when an RMD is due. Customarily, a 1099-R form is sent reporting the distribution. Furthermore, 10% will be withheld from the distribution and allotted for the IRS unless you inform them to withhold more or less. Some IRA sponsors offer an automatic withdrawal plan so your distributions are sent to you at regular intervals.
You do have the option to take the total RMD amount due from either a single IRA or a combination of IRAs, but not from a Roth IRA. Additionally, you can withdraw more than the required minimum, however, you cannot use the surplus to meet future years’ RMD requirements.
In the cases of inherited IRAs and employer-sponsored retirement plans, you must calculate their RMDs separately and the distributions must come from their respective accounts.
Taxes and Penalties
Your Required Minimum Distribution may hit you with a substantial tax bill. The reason is due to the fact that RMDs are taxed as regular income at your federal tax rate and you could owe state taxes on the RMDs as well. Surprisingly enough, many taxpayers over 70½ may find themselves at the mercy of a 55% marginal income tax rate because of their combination of RMD income, capital gains, and Social Security.
The best way to curtail an unpleasant RMD-related tax bill is to begin converting your traditional IRAs into Roth IRAs sometime in your 60s. As mentioned earlier, Roth IRAs are not subject to Required Minimum Distributions. Speak to your tax adviser prior to converting.
In the event that you do not take out your RMD, you could be responsible for a 50% penalty fee. You could face a $5,000 penalty if you would’ve just taken out $10,000. The IRS may offer forgiveness – but only the first time.
Should you miss the RMD deadline and have a valid excuse, don’t send the IRS a payment. Instead, fill out the Form 5329 specifically for RMD penalties and mail it along with a waiver request letter explaining what occurred.
In the meantime, withdraw the required minimum from your IRA as soon as possible. The IRS will alert you with a decision on the penalty waiver – whether it was granted or not.
If you happen to be older than 70½ and have not been meeting your RMDs, contact your IRA sponsor immediately. It will be a priority to determine the amount to withdraw in order to correct the mistake as soon as possible. In the end, the IRS just wants the money you owe, not to incarcerate you.
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