Retirees Should Know These 3 Facts About Required Minimum Distributions - July 09, 2020
Neglecting to withdraw a required minimum distribution (RMD) from an IRA by the due date brings about a painful tax code penalty: 50%. Yes, you read that right. If you are supposed to withdraw at least $4,000 and (uh oh!) did not do as such, you have to write the IRS a check for $2,000. Keep in mind that on January 1, 2020, the RMD rules were modified.
Like the majority of investors, you're most likely working on a retirement portfolio that will provide a large enough nest egg to give you a comfortable retirement. Retirement financial planners refer to this as the "accumulation phase." Your goal in this phase is to choose investments with long-term growth potential - for example, a current top ranked dividend stock like Lockheed Martin (LMT).
But there is a second phase of retirement planning that gets less attention, even though it's the more enjoyable part. It's the "distribution phase," which simply means spending the assets you've worked so hard to accumulate.
Making plans for the distribution stage involves deciding where you'll live in retirement, whether you'll travel, your proposed leisure activities, and more decisions that will affect your spending during your golden years.
Along with those choices, you need to be mindful of the RMD, because it applies to the majority of retirement accounts. This IRS rule requires you to withdraw a specific minimum amount from any qualified accounts you have when you reach a certain age--previously it was 70 1/2, but beginning in 2020, it is 72.
What is the point of this mandatory withdrawal by the IRS? Not surprisingly, it's to be sure that the government gets their tax money. Without the RMD requirement, individuals could live off other income and never pay tax on retirement account gains. That cash could be left to family or friends as an inheritance and the IRS would not receive taxes from it.
The Most Important Things to Know About RMDs
Which types of retirement accounts have RMDs? Qualified retirement accounts like IRA accounts, 401(k)s, 457 plans and other tax-deferred retirement savings plans like a TSP, 403(b), TSA, SEP, or SIMPLE IRA plan require withdrawals in retirement.
When do I have to start taking distributions? For most accounts, you must take your first distribution by April 1 of the year following the calendar year in which you reach age 72. If you retire after that age, you must take your first RMD from your 401(k), profit-sharing, 403(b), or other defined contribution plan by April 1 of the year following the calendar year in which you retire.
Every year after your start date, you are required to take your RMD by December 31. Remember, for Roth IRAs you do not have to take an RMD because you paid taxes before contributing. However, other types of Roth accounts do require RMDs, but you may be able to avoid them (for instance, by rolling your Roth 401(k) into your Roth IRA).
What will happen if I neglect to take my RMD? If you don't take an RMD, or don't take a large enough distribution, you are liable for a 50% tax on the amount that was not withdrawn in time.
How much cash do I need to withdraw? The RMD you are required to take is calculated by dividing your previous year's December 31st retirement account balance by a "distribution period" factor dependent on your age.
Here's an example to give you an idea of the math: Ann is 71 and will take her first RMD in the year following the year she turns 72. Her IRA balance toward the end of the preceding year was $100,000. Her "distribution period" factor is 27.4. Dividing $100,000 by 27.4 equals $3,649.63. This is the amount Ann is required to withdraw for her first RMD.
Learning about the "distribution phase" is just one aspect of preparing for your nest egg years.
To learn more about the tax implications of retirement spending - and much more about retirement planning - download our free guide: Retirement Made Easy.
You'll find useful, detailed steps to help you navigate both the accumulation and distribution phases of retirement planning. Get Your FREE Guide Now
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