Many elderly people I meet with have never heard of RMDs otherwise known as “required minimum distributions”. If you have a 401k, 403b, TSP or IRA, this tax law applies to you!
Whether you have $10,000 or $1,000,000 in your retirement accounts, RMDs apply to EVERY US citizen
The goal of this article is to explain what RMDs are, what common problems to avoid, including a stiff 50% federal penalty and lastly how to be proactive with your RMD planning for all your retirement accounts.
After you read this article you may likely understand why retirement and RMD planning is not a do-it-yourself project.
- RMD Basics
- Common RMD Problems
- RMD Planning Strategies
1. RMD Basics
First, what are RMDs (Required Minimum Distributions)?
Simply put, at age 70 ½ years the IRS requires people to start taking withdrawals from qualified retirements accounts such as 401k’s, 403b’s, TSPs and IRAs.
The first RMD is due to be withdrawn by April 1st of the year after you turn 70 ½, the second RMD is due to be withdrawn that same year by December 31st.
Each year unless the IRS indicates otherwise, December 31st is the deadline to withdraw from your retirement accounts. Otherwise, you may receive an IRS penalty notice in the mail.
Interestingly, the RMD increases every year. This means the amount you are required to withdraw from your IRA or 401k goes up.
The reason for this is due to the fact that RMD tables are based on life expectancy rates. The older you get, the greater the chance of you passing away. As a result, the IRS requires more money to be withdrawn as you age.
Since the saver defers taxes their entire life inside a 401k or IRA, Uncle Sam finally wants his portion of tax money, at a rate of potentially thousands more each year.
What if you have several retirement accounts?
The answer: It depends on the type of account and if you are still working.
RMDs are required to be withdrawn from each employer 401k or Governmental 457(b) separate every year.
For IRA accounts you are allowed to aggregate the RMD amount and take from a single IRA. Multiple 403b’s are also eligible to be aggregated so that you can take your RMD from a single 403b plan.
If you are actively working with your employer past the age of 70 ½ years old, you may continue to defer taking your 401k RMD until you actually retire. The caveat is as long as you are a less than 5% owner of the company you may do this.
However, every IRA owner past 70 ½ years old MUST take their RMD regardless if they are still employed or retired.
As you near 70 years old the IRS should mail you a “Report of RMD” notice. You must complete this form in order to receive an RMD calculation based on IRS regulations.
Many people forget RMDs are also due on both inherited IRAs and Roth IRAs by 12/31 of the year after the owner’s death. What a shame for inherited Roth IRA owners to pay a penalty on an otherwise tax free withdrawal! IRS rules regarding inherited IRAs can be complicated so it is often best to consult with your tax advisor.
2. Common RMD Problems
The most well-known issue related to RMDs is the infamous 50% penalty.
This occurs in three different scenarios: failing to withdraw the calculated RMD amount, taking less than the full amount, or failing to withdraw by the applicable deadline.
For example, if you are retired and did not withdraw your RMD of $10,000 from your IRA. You will be assessed a penalty of $5,000. In addition, you will be required to withdraw the missed RMD and pay applicable federal taxes on the distribution. The 50% penalty or “excise tax” is the highest IRS penalty in the tax code. Plan accordingly!
Another common problem I see is incorrectly taking RMDs based on the different retirement accounts one possesses.
For example, if you are retired with two old 401k’s and one IRA and you only take the RMD from the IRA by the deadline, you will be charged a 50% penalty.
Why? You are penalized on the two RMDs that should have been withdrawn from each of the 401ks. Remember you cannot aggregate the RMDs for 401k’s or 457(b) plans.
It is wise to consult with your Certified Financial Planner and tax professional on situations like these.
The last common problem I often see is many people do not know what their actual RMD amount is for the given tax year. Some are left in the dark by their IRA custodians as to what the accurate RMD calculation is.
“Although the IRA custodian or retirement plan administrator may calculate the RMD, the IRA or retirement plan account owner is ultimately responsible for calculating the amount of the RMD.” - www.IRS.gov
Surprisingly, some IRA custodians do not calculate your RMD for you meaning the onus is on the IRA owner to crunch the numbers using the end of year IRA value and the correct RMD life expectancy table.
Higher net worth couples benefit even more with proper RMD planning given the potential “tax bracket creep” they may encounter. This often results from someone being forced to take higher withdrawals each year from retirement accounts whether they need the money or not.
Keep in mind the IRS does not allow rolling over RMD amounts to IRAs because withdrawals are taxed already and lose the pre-tax status.
3. RMD Planning Strategies
There are only headaches for those that do not properly plan ahead of time. The time to plan is now. “Later” means never.
Start planning as early as in your 30’s based on disciplined savings habits. Should you choose the traditional 401k or Roth 401k option? Comprehensive planning helps answer this question.
If you wait to plan for your RMDs until you retire, it may be too late. Enough damage may have been done based on where you have saved for all those working years.
Here are a few tips to optimize your retirement accounts and mitigate any future RMD tax liabilities:
First, if you are still working and your employer offers you a “Roth 401k”, you may want to consider this type of account. This account works very similar to a traditional 401k except that contributions are made on an after-tax basis meaning you do not get tax deductible contributions. However, money that grows and is withdrawn is tax free with no RMDs as long as you roll into a Roth IRA.
For government workers you have access to the Roth TSP and some medical professionals have Roth 403b’s available to them.
As long as one rolls over their Roth employer plan into a Roth IRA before 70 ½ years old they will not be forced to take required minimum distributions because Roth IRA withdrawals are tax free. This is assuming you meet the Roth IRA rules of having the account open for at least five calendar years and are over 59 ½.
Second, Roth IRAs are RMD friendly. There are no required minimum distributions that need to come out of Roth IRAs.
A Roth IRA is a vehicle you must qualify for based on your adjusted gross income (AGI). For married filing jointly couples, if your AGI is over $196,000 for tax year 2017 you are ineligible to contribute into a Roth IRA.
Thankfully, Roth IRA conversions are allowed to be made by anyone regardless of income. This strategy involves converting a portion of your traditional or rollover IRA into a Roth IRA. A key step is for the amount converted into the roth IRA, one must claim this as income and pay taxes. There is no limit on how much you may convert.
I highly recommend you consult your CFP or CPA regarding roth conversions because of the “pro-rata rule.” They are not appropriate for everyone.
Third, QLACs and QCDs can help. QLAC stands for a qualified longevity annuity contract. For high net worth couples this may be a great strategy to defer your RMDs on certain funds until you are 85 years old instead of 70 ½. You are allowed to invest up to $125,000 or 25% of your qualified retirement money into a QLAC.
QCD stands for a qualified charitable distribution. The IRS allows you to donate your RMD directly to a qualified charity and not have to claim taxes on the RMD amount. The maximum QCD amount per year is $100,000.
Lastly, some other helpful tips to plan accordingly for RMDs is at the end of each year, retain for your records IRS Form 5498 for each of your IRAs. This form shows your end of year value and is needed to determine your RMD amount if your IRA custodian does not do for you.
Consider rolling over old 401k’s to an IRA in order to aggregate your RMD amount each year. IRA rollovers make life easier with RMDs. Read more on this topic on another blog post at www.djavier.com titled “Old 401k? Your Four Options.”
As you can tell by now, RMDs and retirement planning is not a do-it-yourself venture. There are many more factors and strategies to consider when planning for your required minimum distributions at 70 ½ years old and beyond.
Consult with a licensed Certified Financial Planner and CPA. As an independent CFP that is legally obligated to act as a fiduciary for your best interest, I can give you that much needed second opinion via a no-cost review. Contact me below.
The above article is informational in nature only. Individuals should always consult with their tax advisor regarding their personal tax situation.
Dustin Javier, CFP® AWMA®
CERTIFIED FINANCIAL PLANNER™
President | Dean Johnson Advisory, LLC
Securities and investment advisory services offered through Ausdal Financial Partners, Inc. Member FINRA/SIPC. 5187 Utica Ridge Rd., Davenport, IA 52807. (563) 326 2064. www.ausdal.com Dean Johnson Advisory and Ausdal Financial Partners are independently owned and operated.