If you’re nearing retirement age, you may have questions about Required Minimum Distributions or RMDs. The rules surrounding RMDs are sometimes vague and unclear. However, you can face severe penalties for failing to withdrawal the right amount. That’s why it’s important to understand what’s required. Not only can you keep yourself out of trouble, but you can use your RMD to continue reaching your financial goals.
When a retirement account owner reaches 70½, they must start taking their Required Minimum Distribution each, if they haven’t already begun using the account. Basically, if you own a tax-deferred retirement account that you’ve contributed to over the years, the RMDs generally must be taken. Here are some of those type of accounts:
It’s important to note, that Roth IRAs do not follow the same rules. Some retirement plan accounts vary the age at which you must begin RMDs. Be sure you talk with a qualified tax expert to be certain on the rules that apply to your situation.
Couple your end of year balance with the life expectancy factor published by the IRS, and you’ll come up with the RMD. Since your life expectancy decreases as you age, your RMD will increase each year. Your RMD is calculated separately for each IRA, however, if you prefer you can take the total amount from a single IRA. One caveat to that is that RMDs from most employer-sponsored retirement accounts must be calculated and made separately. The same goes for beneficiary accounts.
There’s no rule against taking more than your RMD either. However, don’t do that thinking it will count as excess for future RMD withdrawals. You will face a stiff penalty for not satisfying your RMD. You can expect to pay a 50% excise tax on the undistributed portion if you don’t take it by the yearly deadline.
RMDs are usually treated as ordinary income. That means you are taxed at your income tax rate. However, let’s say you turned 70½ last year. That gives you the opportunity to delay your first RMD until April 1st of the following year. The issue that you could face though is you will still be required take your RMD for age 71 by December 31st of that same year. It’s a good idea to look at your tax picture with a professional to see if taking two RMDs in the same year could change your tax bracket. Speaking with your advisor about tax-efficient strategies could save you a massive headache come tax time.
When you take your RMD isn’t nearly as important as just making sure you take it. Earlier or later in the year has no bearing on your taxes. However, you can take your RMD and make a tax-free transfer to a charity of your choice. If that’s the case, you may want to consider waiting until December. In 2014, Congress temporarily renewed the Qualified Charitable Distribution that expired in 2013. That gives taxpayers a short window of opportunity to make a charitable donation. They may very well do that again in the future as well.
After you’ve pocketed your RMD and paid the necessary taxes on it, you’re free to use the money just like you would any other income. If covering living expenses aren’t necessary, here are some other ways to use your RMD:
While understanding the complexities surrounding your RMD can be confusing, consulting a qualified financial professional can take a lot of the guesswork out of it. They can help you develop strategies to minimize your taxes while supporting your retirement goals.