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, you usually have to plan to start taking out at least a minimal amount when you reach age 70. This amount is called the "Required Minimum Distribution," or RMD (or MRD for "Minimum Required Distribution"). 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.
There are exceptions and calculation methods that depend on the type of retirement account—whether it is in an employer retirement plan, such as a 401(k); whether or not you inherited it from someone who is not your spouse; and whether your spouse is more than ten years younger than you are. If in doubt, ask your tax advisor or your retirement plan administrator, because the penalty for missing a distribution deadline is hefty. For today's discussion, we're referring to Traditional IRA and Rollover IRA accounts, not any kind of Roth IRA or Roth Conversion IRA, and an age difference of less than ten years between you and your spouse.
The first year for RMDs 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 31 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, if you're a 70-year-old with $100,000 in retirement accounts as of December 31, 2018, the IRS table says you should expect to live another 27.4 years. Divide $100,000 by 27.4 and your result is $3,649.64. That's your RMD amount—a little less than 4% of the total.
You can take the amount out in a single withdrawal or stage it to come out periodically before the end of the year. But don't wait too long—prepare ahead to take it on time. If you don't make the withdrawal by the end of the year, there's a 50% tax penalty on the amount not taken. That would hurt!
Simple as this may seem, it is all the exceptions which add to the "when" and "whether" confusion. A common misconception is when you have to take your first RMD. You can delay only that first distribution until April 1 of the following year. Most people won't delay since that means taking two RMDs in the following year, but your tax advisor may recommend waiting. Keep in mind that while you're required to take at least your RMD amount, you can take out more.
Often, retirement plan administrators and retirement account custodians calculate your RMD and remind you to take care of it. They often allow for conveniences such as instituting automatic distributions or Federal and State tax withholding elections. They are also responsible for issuing a tax form (IRA's generate a 1099-R) for you to use to report the amount and any withholding when preparing your tax returns.
A silver lining, if you're charitably inclined, is that you can elect to take some or all of your RMD as a "Qualified Charitable Distribution (QCD)," allowing you to use the amount as a charitable donation deduction for the year. This way, you can accomplish your charitable goals and still satisfy your distribution requirements without a knock from the tax collector.
In the end, the responsibility is yours to see that your distributions are done and properly reported. Talk with your tax advisor. Mistakes can be costly, but understanding and exercising your choices can help along the way.
*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.