It seems like when you get to retirement you should be able to take it easy.
Your money is in a tax-advantaged account, and you can take out money as you need. No reason to fuss about it.
Unfortunately, this isn’t always the case.
While you might think that you can put off withdrawing money from your tax-advantaged account if you have income from other sources, this isn’t true if your account is subject to required minimum distributions (RMDs).
What are RMDs (Required Minimum Distributions)?
The RMD is a required amount that you are forced to take from certain tax-advantaged retirement accounts — even if you don’t need the money.
If you don’t take your RMD when you are supposed to, you can be charged penalties that can reduce the value of your retirement account.
RMDs are not required for Roth IRAs. However, other retirement accounts come with RMDs. This means your Traditional IRA, and other non-Roth IRAs are subject to RMDs. Additionally, all 401(k) and 403(b) accounts are subject to RMDs.
If you want to avoid RMDs, you need to roll your money over into a Roth IRA. But realize that this strategy comes with possible tax consequences, so weigh those against the advantage you get from avoiding RMDs.
When Do You Take RMDs?
Your RMD is based on a formula that takes into account the balances of your qualified retirement accounts, and your life expectancy.
Every year, your RMD changes, since the value of your accounts varies, and you are expected to live one year less. You are required to use the formula to determine your RMD, and then take it at some point during the year.
The good news is that you don’t have to start taking your RMDs immediately. Your first RMD is supposed to be taken by April 1 following the calendar year that you turn 70 1/2. It’s a little bit of an odd calculation, but it’s the way it works.
So, if you turn 70 1/2 in January of 2013, you have until April 1, 2014 to take your first RMD. Of course, if you turn 70 1/2 in December of 2013, you still have to take your first RMD by April 1, 2014.
After that first RMD, all of your subsequent RMDs for the year have to be taken by December 31. It’s important to note that this still applies for the year that you take your first RMD. So, if you have to take your first RMD by April 1, 2014, your second RMD still has to be taken by December 31, 2014.
Realize that you don’t have to wait until your RMDs are “due” to take the money. Many retirees choose to divide the RMD over the year. This can make it a little easier to plan with.
It’s also worth noting that there are exceptions to the 70 1/2 rule. If you are still working when you reach that age, you might be able to put off taking your RMD. Consult a knowledgeable financial professional for more information about whether you might qualify to put off taking your RMDs.
Taxes and RMDs
For the most part, you will pay taxes on the income from your RMDs (exceptions are Roth 401(k) and Roth 403(b) accounts). The distributions are taxed as regular income, at your marginal tax rate. RMDs can boost your taxable income, and, in some cases, even boost you into another tax bracket. RMDs can also increase your income to the point that you might be ineligible for deductions and credits that come with phase outs at certain income levels.
It’s a good idea to check with a tax professional about practical steps you can take to plan your RMDs (or convert to a Roth IRA) to avoid some of the pitfalls associated with RMDs.
What if You Have Multiple Accounts?
Many retirees have multiple qualifying retirement accounts. When you have multiple accounts, you are supposed to figure out your RMD for each account separately. For the most part, your RMDs need to come from each account on a separate basis.
The exception is for multiple non-Roth IRAs. You first figure out your RMD for each account. Then, if you want, you can combine the amount. You can take your entire RMD from one IRA account, or any combination of accounts. However, this rule doesn’t apply to inherited IRAs. Any inherited IRA must be treated separately.
Finally
As if saving for retirement isn’t enough you have to also plan how you will take the money out once you retire. Planning now can help you manage your taxes later on. It may be wise for you to consult a tax or financial professional on how to best manage your required minimum distributions in retirement.
The time you put in now can make your retirement years better.
One additional item regarding RMDs. If you are still working at 70 1/2 or older and you are not a 5% or greater owner of your company your 401(k) account at that employer is not subject to an RMD.
Thanks for the additional insight Roger!
A comprehensive RMD guide, excellent writing, as always.
One side thing to note – you don’t have to sell the asset to take an RMD. Say you are happy with XYZ mutual fund, and your RMD is $5000. You simply tell the broker to transfer $5000 worth of XYZ to you cash side brokerage account, and you’ve taken your RMD. Of course the tax is still due and you need to pay the tax in cash. The new cost basis for the fund shares is the value on the date of transfer, the $5000 in shares you requested be withdrawn.
(I’ve read people who are confused, thinking this is not permitted. It sure is, I’ve done it on behalf of my dear old Mother In Law. Deposits to IRAs can’t be in shares transferred in, deposits must be cash, withdrawals can be “in-kind’, shares of stocks or funds.)
Great info Joe, thanks!