The day you turn 70 is a major milestone, but as far as your retirement accounts are concerned, the really important date comes six months later when you reach age 70 ½. That’s when required minimum distributions (RMDs) begin to come due, allowing the IRS to finally get its cut of the earnings that have been building up over the years in your tax-deferred retirement accounts.
Most types of retirement accounts are subject to RMDs, including traditional IRAs; 401(k), 403(b) and 457 plans; profit-sharing plans; and SEPs, SARSEPs and SIMPLE IRAs. In the case of defined-contribution plans such as 401(k)s, people who are still working at age 70 ½ may be able to delay their RMDs until the year they retire if their plan allows it. The IRS has a helpful RMD comparison chart.
The RMD rules do not apply to Roth IRAs while the owner is alive, but they do apply to Roth 401(k) accounts.
The rules require that you take your first RMD for the year in which you turn 70 ½ and continue to take them every year after that. For just the first year, the law allows you to delay your distribution until April 1 of the following year. But note that if you do that, you’ll need to take two RMDs for that year – one for the prior year and a second for the current year. In subsequent years, you have to take the RMD by Dec. 31.
If you have a 403(b) plan, slightly different rules apply to any contributions you made before 1987. Your plan administrator should be able to explain the rules and indicate which contributions might qualify for special treatment.
The sponsor or administrator of your 401(k) or other retirement plan should help you determine your RMD amount for the year. The custodians of your IRAs may provide guidance too. If you need to calculate your own IRA distributions, you can use the worksheets and tables in the appendices to IRS Publication 590, “Individual Retirement Arrangements (IRAs).”
Taking your RMDs can be a little tricky, at least until you’ve done it a few times. Here are some potential pitfalls you’ll want to watch out for:
1. Taking too little. If you take out too little money, you’ll face a 50% penalty on the difference between the amount you withdrew and the amount you should have withdrawn. If you believe you made an honest mistake in calculating your RMD, you can ask the IRS to waive all or part of the penalty by attaching an explanation to IRS Form 5329, the form you use to report any additional taxes you owe on your retirement accounts.
2. Taking too much. There is no penalty for taking more than the required minimum from your retirement accounts. But there are several reasons you probably don’t want to unless you absolutely need the money for living expenses. For one thing, the money in your retirement account enjoys tax-deferral benefits. For another, the faster you draw down your accounts the sooner you’ll exhaust them, risking the possibility that you might outlive your savings.
3. Waiting too long to start. Some retirees with a substantial amount of money in their retirement accounts can find it advantageous from a tax perspective to begin withdrawals even before age 70 ½. That’s because your distributions could push you into a higher marginal tax bracket.
For example, if you’re a single filer, your first $9,075 in income is currently taxed at 10%, while additional income up to $36,900 is taxed at 15%. If your income exceeds that level, any additional income will be taxed at a higher rate, which can range from 25 to 39.6%.
So if you retire at age 66, let’s say, and have a relatively modest income but a good deal of money in your retirement accounts, you might want to start withdrawals sooner. That will reduce your future RMDs and possibly keep you out of one of those higher tax brackets. If you don’t need the money to live on, you can simply reinvest it elsewhere. These calculations can be complicated, so you will want to consult a knowledgeable tax adviser or financial planner before you make any decisions.
Don’t start too early, though. Any withdrawals you make before age 59 ½ are generally subject to a 10% tax penalty, although there are some exceptions.
4. Taking them all at once. You don’t have to withdraw your entire RMD for the year in one big chunk. Instead, you can make a series of withdrawals as long as they add up to the right total by year’s end. Many retirees will find it convenient to arrange for automatic monthly withdrawals from their accounts, creating a predictable income stream for themselves. Spreading your withdrawals over a number of dates also reduces the possibility that you’ll take out everything on a day when the markets are way down. And for the free spenders among us – you know who you are – a large cash infusion at any one time might be a temptation best avoided.
5. Ignoring taxes. In addition to the other tax considerations discussed here, bear in mind that the income taxes you’ll owe on your RMDs each year will need to come from somewhere. Unless you have enough income or other savings outside of your retirement accounts to cover them, you’ll want to set aside a portion of your withdrawals so you aren’t caught short come tax time.
The Bottom Line
Calculating your required minimum distributions can take some work, but your plans’ custodians and administrators should do much of the number crunching for you. Be especially careful not to withdraw too little and trigger that whopping 50% penalty. Finally, enjoy the money! You earned it.