April 1 is fast approaching, and if you have a retirement account and turned 70 ½ last year, you better be paying attention.
Required minimum distributions are mandatory for various retirement accounts, such as 401(k) plans and individual retirement accounts (IRAs). Taxpayers must start taking these withdrawals by April 1 of the year after they turn 70 ½ (though they can take them in the same year if they choose). RMDs are a set amount of money a retirement saver must withdraw from their account, and there’s a significant penalty for not following through.
See: 5 ways to minimize required minimum distributions
Here’s what else you need to know:
The Basics
• All employer-sponsored retirement accounts, such as 401(k) plans 403(b) plans, 457(b) plans and profit-sharing plans have required minimum distributions. Traditional IRAs and similar plans such as SEPs, SARSEPs and SIMPLE IRAs also apply, though Roth IRAs do not. (Roth 401(k) plans do.)
• The first withdrawal doesn’t need to be made until April 1 of the year after you turn 70 ½, however should a taxpayer choose to delay the payment until the year after they turn 70 ½ they’ll still have to make another withdrawal by Dec. 31 of the same year. All subsequent years’ withdrawals are required by Dec. 31, too.
• If the taxpayer died before taking an RMD, different rules apply to the beneficiary, such as taking the entire benefit within five years of the owner’s death or beginning installments for the rest of the beneficiary’s life starting no later than a year after the owner’s death, the Internal Revenue Service said.
• Everyone’s RMD is different. To know how much of a withdrawal is required, the Internal Revenue Service divides the prior Dec. 31 balance of the account by the life expectancy factor of the taxpayer, and the agency uses its own table to determine that.
• For more, check the IRS’s website here.
The risks of not knowing about RMDs
Not taking your required minimum distribution means you’ll be taxed a penalty of 50% what you were supposed to withdraw. For example, if your RMD is $5,000 and you only withdraw $3,000 from your account, your penalty fee is $1,000, which is half of the difference you were supposed to take. Have a RMD of $5,000 and take none of it, and your penalty is $2,500.
If you choose to delay your first RMD after 70 ½ to the April 1 of the following year and have to take two RMDs in that year, you may bump yourself into a higher tax bracket or increase your income for the year more than you wanted, said Ryan Fuchs, a financial adviser at Ifrah Financial Services in Frisco, Texas.
Don’t miss: 3 tax-saving moves to make right now if you turned 70-1/2 this year
What advisers say you should know
• The calculation is done based on the balance of the account at the end of the previous year. If the account was transferred to a new account, taxpayers have to use the balance of the account from the original custodian (because the new account would have a $0 balance in the prior year), said Allan Katz, a financial adviser at Comprehensive Wealth Management Group in Staten Island, N.Y. The custodian holding your account will send you a letter.
• You can’t put your RMD into another tax-deferred account, such as an individual retirement account or Roth IRA, said Edward Snyder, a financial adviser at Oak Tree Advisors in Carmel, Ind. You can put it into another brokerage account though.
• If you’re still working past age 70 ½ , you can defer taking RMDs from employer-sponsored plans of the company you still work for, Fuchs said. This exception does not apply to IRAs or certain employer-sponsored plans if you own a certain percentage of the company, he added.
Also see: Everything you need to know about required minimum distributions
• You can gift your RMD to a charity (up to $100,000), which would mean not having to report it at all as income, said Eric Dostal, a financial adviser at Sontag Advisory in New York. This strategy is called a Qualified Charitable Distribution, but means you can’t also claim a charitable deduction for the QCD amount on Schedule A. “QCDs are particularly attractive now that fewer people will be itemizing deductions for 2018 and beyond due to the new tax law,” said Laurie Kane Burkhardt, a financial adviser at Modera Wealth in Boston.
• If your spouse is more than 10 years younger than you, there’s a different table of factors to calculate the RMD, which ensures the money lasts longer for your spouse, said Michele Clark, a financial adviser at Clark Hourly Financial Planning in Chesterfield, Mo. “Be sure to use the correct one,” she said.