Retirement savings accounts that allow employees to make pretax contributions have a caveat: at some point, taxes must be paid on that earned income. The Internal Revenue Code generally requires that retirement account owners take a certain amount of money out of those accounts each year, starting when they reach age 70 ½. This is what is referred to as “required minimum distributions,” or RMDs.1
The main reason for this requirement is so that the U.S. government can collect taxes on this previously untaxed money. Therefore, the account owners must take the annual distribution whether they need the money for retirement income or not. If retirees are using these accounts for retirement income, there’s a good chance they are already meeting the requirement and don’t need to take out any more.2
Decisions about when and how much to draw down from retirement accounts should all be part of a carefully crafted distribution strategy. RMDs play a big role here, because they are taxed as regular income. If you don’t need the RMD for living expenses, you could consider reinvesting it in tax-efficient financial vehicles.3 If you’d like some help determining whether to use your RMD as income or to reinvest it, please give us a call.
The IRS has specific rules about how to calculate the annual RMD amount and provides tables to help account owners determine the appropriate amount for their situation. In general, you can figure your RMD by dividing the account balance as of Dec. 31 of the preceding year by the applicable distribution period (life expectancy), as specified in the IRS tables.4
Account owners still working after age 70 ½ may qualify for an exception to the RMD age requirement. They may be able to waive the RMD mandate, but only for the plan of their current employer. If they have other tax-deferred company retirement plans or traditional IRAs, they must take RMDs from those.5 Also, if they own 5% or more of the business sponsoring the plan, they must take their first RMD when they reach age 70 ½, whether they are retired or not.6
The penalty for not taking the RMD each year is steep – 50 percent of the amount that should have been withdrawn. For example, if the RMD is $10,000 and the owner withdrew only half that amount, he or she may owe an additional tax penalty of $2,500 on the $5,000 that wasn’t withdrawn – in addition to the taxes on the amount that was withdrawn.7
Remember, RMDs and a comprehensive distribution strategy are key components of retirement income planning. We believe how and where retirees withdraw money is just as important as how and where they invest it to help build their nest egg.
Content prepared by Kara Stefan Communications.
1 Michael Kitces. Nerd’s Eye View. Oct. 11, 2017. “Rules for Calculating Required Minimum Distributions (RMDs) During Life.” https://www.kitces.com/blog/required-minimum-distribution-rmd-calculation-tax-rules-ira-401k-403b/. Accessed Nov. 9, 2017.
3 Fidelity. July 3, 2017. “Smart strategies for required distributions.” https://www.fidelity.com/viewpoints/retirement/smart-ira-withdrawal-strategies. Accessed Nov. 28, 2017.
4 IRS. Aug. 26, 2017. “Retirement Topics – Required Minimum Distributions (RMDs).” https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds. Accessed Nov. 9, 2017.
5 Liz Weston. Bankrate. March 13, 2015. “Take 401(k) required minimum distributions if working?” http://www.bankrate.com/retirement/401k-required-minimum-distribution-rules/. Accessed Nov. 28, 2017.
6 Marlene Y. Satter. Benefits Pro. April 17, 2017. “10 things to know about RMDs.” http://www.benefitspro.com/2017/04/17/10-things-to-know-about-rmds?ref=hp-news&page_all=1&slreturn=1510256659. Accessed Nov. 9, 2017.
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