For those of you with an employer-sponsored retirement plan or an Individual Retirement Account (IRA), including Simple IRAs, Traditional IRAs, SEP IRAs, and Rollover IRAs, but not Roth IRAs, when the age 70 and ½ rolls around for you, you are then required by the IRS to begin taking a minimum amount, also known as required minimum distributions (RMDs), from your Individual Retirement Accounts and retirement plans, annually.
Therefore, as a retirement plan or Individual Retirement Account owner, you should take the time now to think about how you will incorporate required minimum distributions into your retirement approach. A RMD calculator can help you do this. You should note that the IRS will also view a portion of the withdrawal as ordinary income, which means you will be required to pay regular income taxes on this portion. With that being said, you should also keep this in mind when planning your withdrawals.
Neglecting to take these minimum withdrawals each year will cost you a hefty tax penalty on the amount that you were required to withdraw, which we will cover in more detail later. Likewise, taking too small of a withdrawal each year will also cost you a huge tax penalty. Therefore, it is important to also consider the tax ramifications associated with your withdrawals with the intent of avoiding them altogether.
The taxable portion of your annual required Minimum Distributions can be estimated using an RMD calculator or the IRS’s Required Minimum Distribution Worksheet, which can be accessed via their web page.
How RMDs Work
Overall, Required Minimum Distributions seek to ensure the IRS receives its tax portion of your retirement reserves.
Once you reach age 70 and ½, as long as this is your first time taking a withdrawal from your retirement savings, you will be allowed to put off the RMD withdrawal until April 1 of the next year following. In some cases, you can even delay the withdrawal until the year after your retirement. However, should you choose to put off taking the initial Required Minimum Distributions withdrawal until the following year, you should note that you will be required to withdraw the first as well as the second Required Minimum Distribution within the same year, which means it will put you in a higher tax bracket for that year; therefore, you will also owe much more in taxes. For more information, reach out to one of our tax planning advisors.
Otherwise, you will usually have until December 31 of the same year to withdraw the Required Minimum Distribution, during which time you can either withdraw the distribution in various small payments spread over a specific period or in one single payment.
Once you withdraw the RMD, you are free to do with it as you would like. For instance, you can reinvest all or part of it in a taxable account, withdraw an amount that exceeds the RMD amount and then reinvest it, or you can just simply spend the entire distribution. It’s all up to you, as long as you take the Required Minimum Distribution each year for tax purposes.
Life Expectancy Factor
Your RMD amount is determined by applying a life expectancy factor put in place by the IRS. To calculate the amount of the RMD, your tax-deferred retirement account balance as of December 31 of the year prior to the withdrawal year is divided by your life expectancy factor.
Your life expectancy factor is taken from the IRS Uniform Lifetime Table. To calculate your Required Minimum Distribution, you can use the RMD calculator or using the IRS Uniform Table:
- Locate your age on the table
- Next, find the life expectancy factor corresponds with your age
- Finally, take your retirement account balance as of December 31 of the year before and divide it by your life expectancy.
If your spouse is the only primary beneficiary, and they are more than ten years your junior, you will need to use the Joint Life and Last Survivor Expectancy Table, which can also be found on the IRS’s Publication 590, to calculate the RMD.
Calculating RMDs for Multiple Retirement Plans
Some people have more than one retirement plan, in which case they will need to compute the Required Minimum Distributions amount for each individual retirement account. Although, the RMDs of all the IRAs may be added together to withdraw the total amount from various IRAs or a single IRA. You can also do the same with your 403(b) plans.
In the same regard, if you have multiple employee-sponsored retirement accounts, such as various 401(k)s, you will need to calculate the RMD for every individual retirement account you own and then take the adequate amount from each retirement plan. For more information, check out 401k vs IRA.
RMDs for IRAs
If you have IRA beneficiaries, then upon your passing, their RMDs will be calculated based on their own life expectancies. Many times their calculations are made using a different table.
Sometimes, if your beneficiary is a trust, the RMDs may be calculated using the life expectancy of the trust beneficiary who is the oldest. However, life expectancy distributions are not granted to estates or charities. In many cases, Roth IRA beneficiaries are also required to take RMDs. However, if you are the original Roth IRA owner, there are no RMDs.
When it comes to IRAs, the owner will have to fulfill the yearly Required Minimum Distribution stipulation for the tax-deferred IRA.
If your spouse is the only primary beneficiary, she or he has the option to treat the IRA as her or his own, in which case the spouse will be allowed to take RMDs calculated using the Uniform Lifetime Table. The spouse will also be able to appoint new beneficiaries of their own. She or he also has the option to remain the beneficiary of the IRA, as opposed to becoming the owner. However, she or he will still be permitted various benefits not available to other beneficiaries. One of these benefits includes being able to put off their RMDs until the year the initial account holder would have become age 70 and ½ .
How RMDs are Taxed
Required minimum distributions are taxed by the IRS as regular income, which means distributions will be calculated based on your adjusted gross income for the year. Thus they will be taxed at your appropriate individual federal income tax rate. They may also be subject to both local and state taxes.
When contributing to your nondeductible IRA, the RMD is calculated based on the gross balance. However, your taxable income will be adjusted for after-tax contributions. You should note that this spike in your income may cause you to fall into a higher tax bracket, which will increase your tax liability. It may also increase the taxes you owe for Medicare or Social Security.
To help offset this increase in your taxes due to the required minimum distribution, if you’d like, you can make what is known as QCD, or qualified charitable contribution, which will enable you to decrease your taxable income based on the amount you donate. It can also be used to help fulfill your RMD for the year, provided you meet the requirements.
As stated earlier, retirement plan owners have until December 31 of each year to take the RDM, except if you own an IRA, you may put off the RDM until April 1 of the following year after you become 70 and ½ .
If you fail to take the RDM for the year in which you are required, you will be hit with a 50% federal penalty tax on the difference between the amount you withdrew and the amount you should have withdrawn. Retirement account owners who withdraw less than the minimum required amount will also be hit with a 50% federal penalty tax. Furthermore, you will still be required to withdraw the required minimum amount and also pay income taxes on the amount that is taxable.
For retirement accounts obtained through your workplace, provided you do not own more than 4% of the company you work for, you may have until April 1 of the year following your retirement to take the RMD. However, for those who obtained retirement plans or IRAs through a company they are no longer employed at, this rule does not apply.
Get Help with RMDs
Figuring your Required Minimum Distributions can be complex, depending on the type and number of retirement plans you own. However, consulting with a financial professional who is well adept in employer-sponsored retirement plans and Individual Retirement Accounts and their Required Minimum Distributions can help take the guesswork out of calculating your RMDs. Your financial professional can also help you determine when to take RMDs and if a tax shelter, such as QCD, is appropriate for your situation.
For beneficiaries, inheriting a retirement plan and trying to compute the new RMDs for yourself can also be confusing, sometimes even when using the RMD calculator. Therefore, a financial professional can not only help you understand your rights and requirements under the new guidelines of your inherited asset, but they can also assist you with how to use the RMD calculator to help ensure you meet your IRS obligations.
If you are a spouse who has inherited a retirement plan, in many cases, your financial professional can also assist you with calculating the RMDs for your new beneficiaries as well as help you understand the benefits afforded to you as a sole primary beneficiary.
Quite often, the financial company you have your retirement account with will also provide you with various Required Minimum Distributions services, as well as an RMD calculator, to help make estimating your Required Minimum Distributions much easier. The RMD calculator is also straightforward and easy to use, so there is no confusion when estimating your RMDs.
Furthermore, if you have more than one retirement plan, and they are located at various different financial companies, your financial professional can also assist you with merging your many retirement accounts into their single financial institution to help make calculating and taking your withdrawals simpler. This way, you are less likely to overlook taking the RMD from each of your retirement accounts, which can result in costly tax penalties.
Once you open an account at your chosen financial institution, the company will also usually enable you to set up automatic withdrawals to help further simplify your RMD payments. By having your RMDs automatically withdrawn, it helps assure you make the appropriate payments, and on time, which helps ensure you meet the IRS rules and regulations. It will also help give you peace of mind knowing they are automatically taken care of.
As previously stated, not only can your chosen financial institution help take the guesswork out of calculating your RMDs, but they can help make managing your RMDs easier by enabling you to actually view your estimated RMDs via the RMD calculator, which is a useful tool for planning your retirement revenue strategy.
As an added benefit, you will also have access to the Planning and Guidance Center who will help you review your retirement revenue plan and make any adaptations necessary to help you better prepare for paying your RMDs, including creating a retirement income strategy for taking withdrawals that include all of your retirement income sources.
Lastly, when you partner with a financial professional to plan your retirement account RMDs, you have the comfort of knowing you have access to a qualified representative who is always available to help address any questions or concerns regarding your withdrawals and who can point you in the right direction for best results.
No matter which type of retirement account you have, remember, a missed deadline can cost you a hefty IRS penalty of 50% of the delinquent withdrawal. Keep in mind this penalty also applies to withdrawals made that fall under the Required Minimum Distribution amount.
However, you don’t have to worry about missing the IRS deadline or go about calculating and planning your RMDs alone as a financial professional is always here to help. Or, if you feel comfortable enough, simply use the RMD calculator available on the site to give you a general idea of the minimum amount you will be required to withdraw upon reaching the required retirement age.
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So don’t put off what could possibly be one of the most major factors to planning your retirement income. Instead, enlist the aid of a knowledgeable professional along with the use of the RMD calculator to help you make the most informed financial decisions concerning your account for the most successful retirement revenue plan. Want to learn more about RMD’s? Schedule a 20 minute call* today!