Understanding RMD rules may be the best present you give yourself this year.
If you or someone you know is turning 70½ in 2017, get ready to start taking money out of IRAs and qualified retirement plan accounts. In fact, the Internal Revenue Service (IRS) requires it.
These mandatory withdrawals are called required minimum distributions (RMDs) and they’re taxed as ordinary income. Think of it as a trade for the tax-deferred growth you’ve received on your investments over the years.
The 2017 New Year is the perfect time to start thinking about how to handle your RMDs. Knowing the rules and planning ahead may keep you from paying out more of your hard-earned retirement savings than you need to.
Know which accounts qualify.
Let’s start with the basics, like what retirement accounts are subject to RMD rules:
- Traditional IRAs
- SEP IRAs.
- SIMPLE IRAs.
- 401(k) plan accounts.
- 403(b) plan accounts.
- 457(b) plan accounts.
- Profit sharing plan accounts.
There are exceptions. Roth IRAs, unless inherited, aren’t subject to RMD rules. And you don’t need to take an RMD from a 401(k) account until you retire — if you’re 70 or older, still employed, and don’t own more than 5% of the company you work for.
Time your withdrawal.
According to the IRS, although each year’s RMDs must be taken by Dec. 31 of that year, you can delay taking your first RMD until than April 1 of the year after you turn 70½.1 For example, if your birthday falls between Jan. 1 and June 30 this year, you’ll turn 70½ in 2017 and can delay taking your first RMD until April 1, 2018. If you turn 70½ in 2018, however, you can choose not to make a withdrawal until April 1, 2019.
That sounds great until you consider that waiting will require you take two RMDs in the same year — the delayed RMD from the previous year along with the current year’s RMD. This could move you into a higher tax bracket, subject your Social Security benefits to taxes, and/or expose you to the Medicare high-income surcharge.
Again, going forward, you’ll have to continue taking RMDs from your accounts annually by Dec. 31 each year. You can get more information about RMDs and timing on the IRS website.
Know your RMD amount.
RMD amounts are calculated for each of your accounts separately and generally are based on your age and year-end balances. While many investment firms and retirement plans calculate RMD amounts on your behalf, it’s ultimately your responsibility. You can determine your RMD amount using an online calculator like this one from Financial Engines2 or IRS worksheets.
Use the right life-expectancy table for your personal situation so you don’t withdraw too much and have to pay more in taxes. For instance, if you’re married and your spouse is more than 10 years younger and your sole beneficiary, your RMD will be lower than in other situations.
Once you know the amounts for each of your accounts’ RMDs, you can withdraw from one or all of them to meet your required amount. You should receive 1099-R forms reporting your distributions from each of your accounts that you made your withdrawal from.
Avoid unnecessary taxes and penalties.
Taxes on RMDs are an unfortunate reality. They’re taxed as ordinary income at your federal income tax rate and can be subject to state taxes, too. If you don’t take your distributions or they don’t meet the required minimums, the penalty can be severe — you’ll face a 50% excise tax on the amounts that you were required to distribute from your accounts.3 Speak with a tax professional and financial advisor to find out more.
Ring in the New Year by learning what you can about RMDs so you can be prepared when you turn 70½. It may be the best present you give yourself this year.