This year the youngest Baby Boomers are turning 50. Over the next couple of years the oldest Baby Boomers will hit 70 ½ which means it will be time to begin taking required minimum distributions from their IRAs, 401(k)s, and other retirement accounts. Here are 7 things you need to know about required minimum distributions.
The penalties can be steep
The rules were changed a number of years ago to require custodians such as Schwab and Fidelity to report the amount of your annual required minimum distribution to the government. In the past this had not been the case. This was part of an effort to enforce the taking of these RMDs and the payment of the taxes associated with these distributions. The penalty for not taking an RMD is steep, 50% of the amount not taken.
As an example, if your RMD is $20,000 and you don’t take it you would owe a penalty of $10,000 on top of the taxes associated with the $20,000 distribution from your retirement account.
Be aware of the total required minimum distribution
If you have multiple retirement accounts you will likely receive a separate RMD amount for each account. Note that the total of your required minimum distributions is what counts, you can generally take the entire amount of the distribution all from one account or from some or all of your various accounts as long as the total amount taken is correct.
Your first required minimum distribution will be for the year in which you turn 70 ½. For example if you turn 70 on January 1 you would be 70 ½ on July 1 and you would have a required distribution for the current calendar year, 2014.
If your birthday is September 1 however, your first distribution is not required until 2015 since that’s when you turn 70 ½.
For your first RMD only, you are not required to take the distribution until April 1 of the calendar year following the year in which you turn 70 ½. So for the January 1, 2014 birthday that would be April 1, 2015, for the September 1 birthday that would be April 1, 2016.
However all subsequent RMDs must be taken by December 31 of the appropriate year. So delaying the first year distribution until April 1 of the following calendar year would mean that you would be taking two distributions in the same calendar year and paying tax on both for the same calendar year. Often for this reason I suggest taking the first distribution in the year that it applies to, for example 2014 in the January 1 birthday example.
How on earth is this calculated?
Your required minimum distribution for a given year is calculated based upon your age and the total of your retirement account(s) at December 31 of the prior year. The calculation is based upon IRS tables in their publication 590.
For example if your are 75, married with a spouse who is not more than 10 years younger than you, and your IRA account balance was $500,000 at the end of 2013 your RMD for 2014 would be approximately $21,834 using the table. I generally rely on calculations by the custodian for a number of reasons, but it is always a good idea to double check. There are a number of online RMD calculators including this one.
Required minimum distributions are not always required
If you are 70 ½ or older and still working there is a specific exception to the RMD rule. This pertains only to the 401(k) or similar plan of your current employer. Additionally it only applies if you are less than a 5% owner of the company. If both conditions are satisfied you do not have to take an RMD on that plan. Any other IRAs, an old 401(k), or similar accounts will still have a required minimum distribution. Note not all plans have this exception so it is best to check with your retirement plan administrator if you are in this situation.
Inherited IRAs and required minimum distributions
Inherited IRAs are a specific type of account that usually comes into play with a non-spousal beneficiary. As an example a parent who is a widow or widower might leave their IRA account to their adult children.
Let’s say the mother is a widow with a $100,000 IRA and she names each of her two adult children as beneficiaries. Upon her death each child would have some options including setting up an inherited IRA account which has some specific rules.
If the mother had already started taking required minimum distributions from her IRA then the children would need to continue taking RMDs from their inherited IRA accounts. However their distributions would be based upon their life expectancy tables resulting in relatively smaller distributions then would have been required by their mother. This is a great situation if the goal for the kids is to preserve and grow the inherited IRA account.
Roth IRAs and required minimum distributions
One of the major benefits of a Roth IRA account is that the owner is not required to take required minimum distributions, a definite plus. This might be a factor among many in deciding whether a Roth IRA is the right way to go for you.
Note inherited Roth IRAs have different rules for non-spousal beneficiaries. If this is your situation you should contact a financial advisor who understands this issue.
Certainly this list is not exhaustive. Required minimum distributions play an important part in both your retirement planning and potentially your estate planning. If you have questions make sure you contact a tax or financial advisor who understands this complex area.