If you're turning 70 1/2 years old, and have assets in defined-benefit plans such as traditional IRAs or 401(k)s, you're subject to required minimum distributions (RMDs). Here are some things to know.
Are you about to celebrate your 70 1/2 birthday? Do have any tax-deferred retirement accounts, such as a traditional IRA, 401(k), 403(b), profit-sharing, or other defined-contribution plan?
If so, you’re about to get familiar with three letters: RMD. That’s short for required minimum distribution—an amount the government requires you to take from your tax-deferred accounts each year. (The exception is a Roth IRA—more on that in a bit.) More importantly, as you take each distribution, you’re essentially declaring it as income, which means it’s time to pay taxes on it.
It’s required. According to RMD rules, failure to take one can be costly, as the IRS will assess a penalty in the amount of 50% of the difference between your RMD and what you actually withdrew from your tax-deferred accounts. For example, if you have an IRA with a required minimum distribution for the current year of $12,000 and you only took, say, $5,000, you would be assessed a penalty of half the $7,000 difference, or $3,500. Yowza!
After decades of diligent saving, all while allowing your nest egg to grow with no taxes assessed along the way, it would be a shame to take such a massive hit. So it’s important to pay attention to the requirement.
It’s a minimum amount. Why does the IRS care if you take a minimum amount each year? Well, remember: when you made these deposits into your account (perhaps through a deduction from your paycheck), they were taken off the top line, before any taxes were paid.
Tax-deferral can be a generous incentive, one that was put in place to encourage people to save for retirement. Once you reach retirement age, it’s mission accomplished, which means, as far as the IRS is concerned, it’s time to pay taxes on at least a minimum amount each year.
When you turn 59 1/2 you can begin taking distributions and paying taxes on them, but doing so isn’t mandatory until age 70 1/2. If you continue working, or if you simply have no need for the money, there’s probably no reason to start taking distributions early. In fact, when you’re working, you might still be contributing to a plan. Once you turn 70 1/2, though, you can defer no longer.
It’s a distribution, and here’s what you need to know:
How much do you need to save to reach your retirement savings goal? Find out by answering a few questions
RMDs will vary from person to person and account to account, and are based on two factors:
To figure the RMD amount, you divide the account balance by the distribution period, as shown in one of three tables provided by the IRS (worksheets and tables are available on the IRS website). Most likely, though, you won’t be required to do the math; typically the custodian of each of your eligible accounts—a broker, bank, or plan sponsor, for example—will calculate the RMD for you each year.
According to RMD rules, the first one is due the year you turn 70 1/2, but you can postpone it to no later than April 1 of the following year. After that first year, the annual deadline is December 31. Although you can delay that first RMD into the next calendar year, that means you’ll be taking two in that second year; one by April 1, the other by the end of the year.
But here’s an R you can ignore (somewhat) when considering RMDs: Roth. If you have a Roth IRA, no RMD is required. Unlike a traditional IRA, where funds are tax-deferred until withdrawn, a Roth IRA is taxed up front, and is tax-free when you take it as a distribution. However, this is only true during the lifetime of the owner. Afterward, a Roth IRA is subject to RMDs, and the same 50% penalty will apply, unless a surviving spouse is the sole beneficiary. If a surviving spouse inherits a Roth IRA, he or she can become the new account owner (by rollover), and would not be subject to RMDs during his or her lifetime.
Here are a few more facts and considerations about RMDs:
Required minimum distributions shouldn’t be considered a government tax grab, but rather a fact of retirement investing. If you’ve saved and invested diligently over the years, it’s likely you’ve gotten the better end of the deal tax-wise, as investments hopefully grew without taxes being assessed along the way.
You don’t have to liquidate holdings to take the RMDs, but rather you can transfer securities into a taxable account if you wish. Just know that you’ll need to pay taxes on the value of such securities at the time of transfer. Plus, you might be required to pay transfer fees. Some investors choose to liquidate enough securities to cover the tax bill, then transfer an amount equivalent to the RMD into a taxable account.
And remember, if your budget allows it, you could use the RMD as additional “fun money." After all, isn’t that what retirement is all about?
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
TD Ameritrade does not provided tax advice, please consult your tax advisor.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.