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ABCs of RMDs: Required Minimum Distribution Rules for Retirement

As the first boomers turn 70, these retirement plan rules become key

If you’re among the 2.1 million boomers turning 70 in 2016, happy birthday! The Internal Revenue Service (IRS) has a gift that you might not be delighted about: You’ll need to start taking Required Minimum Distributions (RMD) from your retirement plans — OK, technically RMDs begin at 70½, but it’s not polite to quibble about age in public.

Let me run through the ABCs of RMDs so you don’t wind up getting socked by the 50 percent tax penalty for noncompliance — yes, you read that right. (Think of RMDs as the IRS’s version of WMDs.)

And if you’re one of the other 74 million boomers age 52 to 69, you’ll want to learn how Required Minimum Distributions work, too. After all, with luck, your time will come.

What RMDs Are

Once you turn 70½, the IRS requires you to take a certain amount of money out of certain retirement accounts every year. That’s to help ensure the government gets tax revenue from tax-sheltered retirement accounts.

If you don’t take out your Required Minimum Distribution, you may be liable for a 50 percent penalty to the IRS.

“They want every dime taxed before you die,” says Kevin McCormally. senior vice president and chief content officer at Kiplinger’s. Incidentally, McCormally wrote an excellent article about RMDs that’s worth checking out: 10 Things Boomers Must Know About RMDs from IRAs.

The accounts subject to RMDs are:

  • Traditional IRAs
  • Rollover IRAs
  • Inherited IRAs
  • SEP IRAs
  • 401(k), 403(b) and 457(b)s
  • Keogh Plans

There are no Required Minimum Distributions for a Roth IRA (unless you inherited the account), though RMDs are required for Roth 401(k)s.

When You Need to Take Your RMD

Exactly when you need to make your first Required Minimum Distribution is more complicated than you might think. But RMD rules are tax rules, so you shouldn’t be too surprised.

You have to take your first Required Minimum Distribution no later than April 1 of the year after the year you turn 70½. So that would mean April 1, 2017 if you turn 70 from Jan. 1 through June 31 this year; April 1, 2018 if your birthday is July 1 through Dec. 31. After your first RMD year, you need to make your required distributions by December 31 of each successive year.

But here’s why you don’t want to wait until April 1 of the year after you turn 70½: Then you’ll have to take two distributions in the same year, and that could elevate you into a steeper tax bracket, increasing your taxes due.

Charles Schwab, which has an excellent, free online guide to RMDs, notes that there’s one exception to these rules: If you’re 70 or older, still working and don’t own more than 5 percent of the company you work for, you can delay your RMD from a 401(k) until you retire.

How Much You Need to Take Out

The size of your Required Minimum Distribution will be determined, generally speaking, by the amount of money in your retirement accounts and the IRS’s life expectancy estimates.

Most people turning 70½ this year will need to tote up the balance of their RMD-eligible accounts and then divide the total by the IRS’s figure: 27.4. For example, say you have $200,000 in traditional IRAs. In that case, you’ll need to withdraw $7,299 ($200,000 divided by 27.4).

And the exception to the rule: If you’re married and your spouse is more than 10 years younger and will be your sole beneficiary, the RMD will be less than it would otherwise be because you can use the IRS’s “joint life expectancy” method.

You can avoid doing the calculation yourself by using a free online RMD calculator: Kiplinger’s has one and so do most major financial-service companies.

The financial firm holding your IRA will likely let you know an RMD will be due and send you a 1099-R form reporting the distribution. The company will also withhold 10 percent of the payout as taxes for the IRS unless you tell it to withhold more or less. Some IRA sponsors let you set up an automatic withdrawal plan and get the distributions sent to you at regular intervals.

Although you have to calculate the RMD separately for each IRA, you can take the total RMD due from either a single IRA or from a combination of them — but not from a Roth IRA.

Also, although you can withdraw more than the required minimum, you can’t use the excess to meet the RMD requirements in future years.

For employer-sponsored retirement plans and inherited IRAs, you must not only calculate their RMDs separately, you must make the distributions from their respective accounts.

RMD Taxes and Penalties

Your Required Minimum Distribution can sock you with a stiff tax bill. That’s because RMDs are taxed as ordinary income at your federal income tax rate and you may owe state taxes on the money, too.

Citing an example from the Social Security Timing software program for financial advisers, InvestmentNews columnist Mary Beth Franklin this week wrote that some taxpayers over 70½ can find themselves subject to a 55 percent marginal income tax rate due to a combination of RMD income, Social Security benefits and capital gains.

“Some advisers say if it looks like your RMD will push you into a higher bracket, start taking the money out before that,” says McCormally.

Another way to avoid a painful RMD-related tax bill: In your 60s, start converting some of your traditional IRAs to Roth IRAs, which won’t be subject to Required Minimum Distributions. Talk to your tax adviser before going that route, though.

If you don’t take out your Required Minimum Distribution, you may be liable for the 50 percent penalty. For instance, say you should’ve taken out $10,000 but didn’t withdraw a dime. Then you’d be slapped with a $5,000 penalty. Yikes.

But the IRS will likely be forgiving — the first time.

“If you have a decent excuse, they’ll waive the penalty,” says McCormally. “You just need to show good faith.”

If you do miss the RMD deadline and have a reasonable excuse (your tax preparer gave you bad advice or you were seriously ill, for instance, says McCormally), don’t send the IRS a check. Fill out the Form 5329 for RMD penalties and mail a waiver request letter with it, explaining what happened.

Meantime, pull out the required amount from your IRA as soon as you can. The IRS will let you know if your penalty waiver is granted or if you’ll owe it.

And if you’re over 70 but haven’t been making your RMDs? “Call your IRA sponsor, figure out how much to take out and correct the mistake as soon as possible,” says McCormally. “The IRS wants your money. They don’t want to put you in jail.”

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