Required Minimum Distributions – RMD

Nest Egg

Required Minimum Distributions (RMD). Whenever you save pre-tax money, whether in an IRA or employer plan such as a 401(k) or 403(b), you create what’s called a “qualified” account: money that is designated for special tax treatment by your custodian, and subject to certain rules. You are probably familiar with the rules governing early withdrawal of these funds. In general, any distributions prior to age 59 ½ are fully taxable and subject to a 10% penalty (certain exceptions apply). This rule is intended to encourage us, as investors, to put away money during our working years that we do not draw on until we need it in retirement. This is why such vehicles are called “tax-deferred” accounts.

The IRS does not intend for us to escape taxation on these funds indefinitely. From age 59 ½ to 70 ½, you have the option to withdraw IRA funds without penalty, in taxable distributions. After age 70 ½, you are required to withdraw a certain portion of the account each year, and there is a steep penalty if you fail to do so. This is the concept of “Required Minimum Distributions,” or RMD. The intent of this rule is to ensure that these funds are withdrawn and taxed during your lifetime. The IRS has not yet figured out how to regulate when we die, so often there is money left over, but the RMD process is intended to deplete the account during your lifetime. That is why the percentage of funds you need to withdraw increases slightly each year.

In the year you turn 70 ½, you are required to take a distribution. It will always be figured from the balance in your accounts as of December 31 of the prior year. In the first year only, the distribution may be taken as late as April 1 of the following year. However, we usually advise clients to take it prior to the end of the first calendar year. If you wait until the April deadline, you will then have to take a second RMD in the same calendar year, which might have adverse tax consequences. You can always take out more than the required amount, but you shouldn’t take less, as the tax penalty will be 50% of the amount you should have withdrawn.

At the end of IRS publication 590, Individual Retirement Accounts, you will find tables in appendix C that show you how to calculate the amount you need to withdraw each year. For example, at age 70 ½ the required minimum distribution is 3.65% of the prior year-end balance (as of 12/31) in your IRA. Your custodian (who knows exactly how old you are) will usually send you a notice near the beginning of the year that tells you what your RMD will be for the coming year. Clients who are spending the money may wish to take it in installments. Those who are adding their distributions to taxable savings accounts often prefer to take their RMD late in the year, to take advantage of tax-deferral as long as possible.

You are allowed to aggregate the RMD amount for all of your IRA’s and withdraw from one account, if that is more convenient for you. You can do the same with your 401(k) plans, if you have not yet rolled them over into IRA’s. However, you may not aggregate different types of accounts. For example, if you have two IRA’s, each with an RMD of $2,000, you may take a distribution of $4,000 from either or them if you prefer. However, if it’s one IRA and one 401(k), you must withdraw $2,000 from each.

It’s important to note that “IRA” here refers to traditional IRA’s. Roth IRA’s are funded using after-tax money, distributed tax-free, and are not subject to required distributions at any point.

If you have any comments or concerns, please don’t hesitate to call us at 408-551-6100 or toll free 800-927-8314 and ask to speak with one of our financial advisors or complete the form below to send us an email.

Best Regards,

Retirement Capital Strategies
A Registered Investment Advisor
1190 Saratoga Ave, Ste. 140
San Jose, CA 95129
Tel (408) 551-6100
www.rcsadvisor.com

Source: This article was written by Margaret (Peggy) Stephan, CFP® – LPL Registered Representative at Retirement Capital Strategies.

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