The December 31st deadline is approaching fast… don’t forget to take your Required Minimum Distribution!
What are required minimum distributions (RMDs)?
Required minimum distributions, often referred to as RMDs, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty.
The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime.
Which retirement savings vehicles are subject to the RMD rules?
In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive. Although you are not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will generally be required to take distributions from the Roth IRA after your death.
Employer-sponsored retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your employer-sponsored plan, you should consult your plan administrator or a tax professional.
When must RMDs be taken?
Your first required distribution from an IRA or retirement plan is for the year you reach age 70½. However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year.
Since this first distribution generally must be taken no later than April 1 following the year you reach age 70½, this April 1 date is known as your required beginning date. Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year–your first year’s required distribution and your second year’s required distribution.
There is one situation in which your required beginning date can be later than described above. If you continue working past age 70½ and are still participating in your employer’s retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own five percent or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.
How are RMDs calculated?
RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made.
If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. (Similar rules apply to Section 403(b) accounts.) If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.
Should you delay your first RMD?
Your first decision is when to take your first RMD. Remember, you have the option of delaying your first distribution until April 1 following the calendar year in which you reach age 70½ (or April 1 following the calendar year in which you retire, in some cases).
You might delay taking your first distribution if you expect to be in a lower income tax bracket in the following year, perhaps because you’re no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution must be made on or by December 31 of that same year.
Receiving your first and second RMDs in the same year may not be in your best interest. Since this “double” distribution will increase your taxable income for the year, it will probably cause you to pay more in federal and state income taxes. It could even push you into a higher federal income tax bracket for the year. In addition, the increased income may cause you to lose the benefit of certain tax exemptions and deductions that might otherwise be available to you. So the decision of whether to delay your first required distribution can be important, and should be based on your personal tax situation.
What if you fail to take RMDs as required?
You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 50 percent tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year.
Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan.
What if I don’t need the RMD?
Once the distribution amount is calculated, an individual can then choose where he or she would like that money to go. Depending on circumstances, if the money is not needed for living expenses, it may be beneficial to keep the money invested within one of your other non-qualified accounts such as a Trust or Individual account. This allows the dollars to stay invested and potentially growing as a nest egg for the future.
Another idea for the money could be a qualified charitable distribution (QCD) (Click here for last weeks discussion on charitable giving strategies). Instead of the money going into one of your accounts, a direct transfer of funds would be payable to a qualified charity. There are certain requirements to determine whether you can make a QCD. For starters, the charity must be a 501 (c)(3) and eligible to receive tax-deductible contributions, and, in order for a QCD to count towards your current year’s RMD, the funds must come out of your IRA by the December 31 deadline. The real beauty about this strategy is that the QCD amount is not taxed as ordinary income.
Have additional questions? Don’t know where to start? Don’t worry! Contact our team today for more information on RMD planning strategies.
Article provided by Broadridge Investor Communication Solutions, Inc.
This information has been obtained from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax adviser to assess your situation. Neither Raymond James Financial Services nor and Raymond James Financial Adviser renders advice on tax or legal issues, these matters should be discussed with the appropriate professional.