Each year about this time we send a notice to all eligible clients reminding them they need to take the Required Minimum Distribution (RMD) from their IRAs before year-end. For those investors wondering what the fuss is all about, we thought we would put together the following primer on IRA distribution rules.
What Is an RMD? One of the great benefits of an IRA is that earnings on the invested funds are not taxed annually. In exchange for this tax break, as part of IRA’s enabling legislation back in 1974, the IRS required that individuals begin taking annual minimum distribution no later than April 1st of the year after they turn age 70½. The deadline for annual withdrawals after this first year is always December 31st. Participants in other qualified company retirement plans such as 403-(b)s and 401-(k)s are also generally subject to these same rules, but if they are still working at 70½, they may be able to delay taking distributions until retirement. The exact rules governing their distribution will depend on their individual plan’s requirements.
How Much do I Need to Take Out? For owned IRAs, the withdrawal amount is calculated by dividing the retirement account balance at the end of the previous year by a factor based on your life expectancy as determined by the IRS. In the case of Inherited or Spousal IRAs, the withdrawal calculation may, under certain circumstances, be based on the original owner’s life expectancy. Your Custodian or Financial Advisor can help you determine the amount.
If I Own More Than One IRA do I Need to Take an RMD from Each Account? The regulations allow you to calculate the RMD for each IRA and then take the total out of any one or combination of IRA accounts. The same holds true if you have multiple 403-(b) accounts. You cannot, however, use IRA distributions to meet the RMD requirements of your other qualified company retirement plans and for 401-(k) plans specifically you must calculate and withdraw a separate RMD from each account.
Does it Matter When in the Year I Take My RMD? No. You can take your RMD in any increment over the course of the year as long as the total withdrawals add up to the required amount. In theory, the longer you leave the funds invested the more opportunity you have for tax-free growth. But if taking your distribution early in the year helps with budgeting or spending, then go ahead. One easy option is to simply instruct your Custodian to direct deposit your RMD into your checking or savings account each year.
What About Taxes? One reason accountants are so happy to see clients make annual contributions to a Traditional IRA is because they are generally made with pre-tax dollars. (This is not the case for Roth IRAs where contributions are made with after-tax dollars.) In exchange for the upfront tax break offered by Traditional IRAs, the IRS stipulates that all related withdrawals are taxed at ordinary income tax rates. While you can wait to pay the taxes on this income until April each year, most Custodians allow you to have a set percentage automatically deducted from your RMD as a prepayment against your state and federal tax levy.
What Happens If I Don’t Take the Required Amount? The penalty for not taking all or part of your RMD in any given year is a hefty 50 percent of the amount not taken. The paperwork required to put withdrawals in place can take some time so be sure to get an early start on this process. Most investors have worked hard to accumulate their retirement nest eggs. Complying with RMD distribution rules is an important step to making sure you enjoy the fruits of your labor!