Since the penalties for not getting required minimum distributions (RMDs) right or severe, I thought it would be a good time to review the rules and deadlines to help you get it right.
RMD rules are complicated and making mistakes by not following them are costly. If you miss taking an RMD or take out less than what is required, you will pay a 50% penalty. Yes, you read that right, a 50% penalty.
So let's start with the basics and go from there.
Why you have to take RMDs
In most cases, you have never paid tax on contributions to your employer's retirement plans (401(k), 403(b), 457 plans, etc.) and traditional IRAs. Also, you have never paid taxes on the earnings in these accounts. That's one of the significant advantages of these plans. The exceptions are accounts where you paid taxes on contributions before making them.
Any money taken out of these retirement accounts is added to your income and taxed at that year's calculated tax rate. If allowed, many investors would prefer to keep their money in these accounts forever to avoid paying taxes.
However, the IRS is not going to let that happen. The result – the required minimum distribution.
When RMDs must start
If you were born between July 1, 1946, and June 30, 1947, you turn 70 1/2 in 2017; you must take your first distribution from your IRA accounts. In general, you need to make these distributions by December 31 of the year they are due.
The exception to that rule is the first distribution. The IRS allows you to delay that first distribution until April 1 of the year following the year you turn age 70 1/2. If your birthday falls within the dates mentioned above, you could delay your first distribution until April 1, 2018. If you do that, the IRS requires you to take two distributions in 2018. Why?
Remember, the rule says you can only delay taking your first distribution before the end of the year. After that, all RMDs are due by December 31 of the year they are due. Since you have an RMD due for 2018, that distribution is due by 12/31/2018. Thre result – both your 2017 and 2018 distributions come out in 2018. Is that a bad thing? It depends. Taking both in one year means you have a higher tax bill due. You may not want that.
What determines the RMD
- Life expectancy
- IRA account balance
Use your age on December 31. In our example, those born in 1946, are age 71 on December 31. Those born in 1947, use age 70. You get the life expectancy from the IRS Uniform Life Expectancy table. Your IRA account balance is as of December 31 of the year before you turn 70 1/2. In our example, that the balance on 12/31/2016. The IRS publishes a Required Minimum Distribution Worksheet to help investors calculate RMDs.
Here's how it works. If you are age 71 on 12/31/2017, the IRS says your distribution period (factor) is 26.5 years. Assuming an account balance of $100,000 on 12/31/2016, your RMD is $3,773.58 ($100,000 divided by 26.5). If you are married and your spouse is ten years younger than you, use the IRS Joint Life Expectancy table to get your factor. You can find the life expectancy tables and distribution rules in IRS Publication 590-b.
Taking your RMD
Once you know your RMD amount, the next decision is how and when to make it. If it's your first, decide whether to withdraw it the year you reach 70 1/2 or by April 1 of next year. You pay taxes based on the year money is distributed. So, by delaying, you would take two distributions in one year and pay taxes on both in a single year. If you have more than one IRA, calculate each one separately.
Once calculated, you have two choices on how to take them:
- Take each calculated RMD from each account separately
- Aggregate all RMDs and take the total from one account.
This option is only available for IRAs. If you are no longer working and have more than one employer retirement plan, you must calculate and take RMDs from each account separately.
The penalty for missing your RMD or not taking enough are 50% of the amount you should have taken less the amount withdrawn. For example, if your RMD was $20,000 and you only took out $10,000, you would be required to take out the $10,000 (and pay taxes on it) plus pay a penalty of $5,000 (50% of $10,000). You don't want that to happen.
If you have not taken your RMD for 2017, you have until December 31. If you turned 70 1/2 this year, you have until April 1, 2018. Remember, if you wait you will need to take both your 2017 and your 2018 RMDs next year.
Call your advisor, fund company, bank, or broker if you need help. Whatever you do, don't get hit with the 50% penalty for not getting it right.
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