They’re as sure as death and taxes: required minimum distributions (RMDs). If you’re 70½ and own an IRA or qualified retirement plan account like a 401(k) or 403(b), the tax code requires you to take annual distributions. But you have some flexibility on how you take them and when you have to start. And you also have options for delaying or avoiding them.
First, a quick review: Uncle Sam created tax-deferred investment vehicles, but with a few catches. RMDs are one of those. In exchange for tax-deferred growth on your investments, you’re required to take a minimum amount of money from your accounts when you reach age 70½. Failing to take your full RMD on time triggers a huge IRS penalty of 50 percent on the required distribution amount.
You can defer your first RMD until April 1 the following year you turn 70½, and must take it by Dec. 31 in subsequent years. Even though you can postpone your first RMD until the following year, taking two in one year could increase the income tax you owe.
When do RMDs start?
You don’t have to wait until you’re 70½ to take distributions. As early as age 59½, you can do so without paying a 10 percent early withdrawal penalty. You figure annual RMDs by dividing the value in your eligible accounts on Dec. 31 the prior year by a life expectancy factor based on your current age and marital status. Life expectancy factor tables are available at IRS.gov.
The Feds tax distributions as ordinary income; there could also be tax due at the state level. Also, the taxable amount depends on whether contributions were made with pre-tax or after-tax dollars, or in the case of contributory IRAs, whether contributions were deductible or non-deductible.
Taking more than required
You can always take more than required, but first consider the impact it may have on your tax bill. Another thing to keep in mind is that sometimes the taxable income you get from your RMDs increases taxes on your Social Security benefits. Finally, if you take more than is required, you may run the risk of depleting your retirement account more quickly than you want to.
Distributions can be in the form of cash or as “in-kind” withdrawals. If you own individual stocks, for example, you can change the registration from your IRA to your taxable account. Doing this would allow you to avoid commissions on selling and re-buying the stock.
Avoiding or delaying RMDs
If you’re not interested in taking RMDs, you have a couple of options. One is converting all or some of your retirement money to a Roth IRA. You’ll have an extra tax hit in the year you convert, but your money would not be subject to annual distribution requirements when you reach age 70½.
If you’re still working and own less than five percent of the company you work for, you may have the option of moving IRA-Rollover accounts and eligible contributory IRA assets into your employer’s qualified retirement plan. This would allow you to delay RMDs until after you retire; check with your employer to find out if its plan allows for such transfers.
Other RMD considerations
If you own one contributory IRA or five, your annual RMD is based on the aggregate value in all such account(s). That’s also the case for other types of retirement accounts like inherited IRAs, 401(k)s, 403(b)s, etc. However, you can take your total RMD in each category from any applicable account. For example, if you have three contributory IRAs, you can meet your annual RMD by taking money from one, two or all three accounts. The same is true for 401(k) or 403(b) accounts and others.
As always, talk with a tax professional and investment advisor as you look at ways to manage RMDs.