Required Minimum Distributions—Pay up! Or Don’t.Submitted by HearthStone | Private Wealth Management on June 11th, 2019
Required Minimum Distributions—Pay up! Or Don’t.
By Paul Hynes, CFP®
You’re retired, enjoying the freedom, and living the life. If you’ve also reached the ripe old age of 70, then it’s time to pay up—in this case, to the IRS.
If you have any type of retirement account, such as an IRA, then you can’t keep all of your funds in the retirement account indefinitely. Generally, you have to start taking out at least a minimal amount when you reach age 70. This amount is called the “Required Minimum Distribution,” or RMD. Note that RMDs don’t apply to ROTH IRAs.
The amount you take out will be added to your income for the year, and will likely be taxable. That means you’ll be paying your taxes to the IRS and State tax collectors.
The first year for RMD’s is the year you turn 70 1/2.* So, if your birthday falls before July 1, then it’s the year you turn 70. If your birthday falls after July 1, it’s the year you turn 71. After that, you’ll continue to take out an RMD each and every year.
The formula for calculating your RMD is fairly simple. First, add up the total value of all of your retirement account balances as of December 31st the prior year. Then divide that balance by your remaining life expectancy, per the IRS Uniform Lifetime Table. The result is your RMD for that year.
For example, let’s say you have $100,000 in retirement accounts on December 31, 2018. At age 70, the IRS table says you should expect to live another 27.4 years. You divide the dollar amount by the years and arrive at $3,649.64. That’s your RMD amount—a little less than 4% of the total.
You can take the amount out in a lump sum or periodically. You can take it all on January 2nd, or December 31, or any date in between. But, don’t wait too long. If you don’t take your RMD during the year, there’s a 50% tax penalty on the amount not taken. That would hurt!
Simple as it may seem, there are exceptions, and this is where it can get confusing. One exception is if you’re still working, then you can wait until you retire. Another exception is for the very first RMD, which you can delay taking until April 1 the following year. This rule is for people who forget and go “oops.” Most people won’t want to delay, since that means you’ll have to take two RMDs in the following year. And, if your spouse is 10 or more years younger, you will use a different Life Expectancy Table. Keep in mind that while you’re required to take at least your RMD amount, you may take out more.
If you’re charitably inclined, you can make a contribution directly from your retirement account to a qualified charity, and avoid the taxes altogether. This is called a “Qualified Charitable Distribution.” The amount contributed to charity counts toward your RMD but won’t be added to your income for the year. This way you can accomplish your charitable goals and don’t have to pay up.
Most, if not all of the account custodians, such as Schwab, will calculate your RMD and remind you to take care of it. However, in the end, the responsibility is yours to see that it’s done. Talk with your tax advisor. Mistakes can be costly.
*The House of Representatives has passed a bill raising the age to begin RMDs to 72. We’ll have to wait and see if this ultimately becomes law.