Many are unaware of IRS distribution requirements and the penalties associated with failing to comply with these requirements, including tax traps.
Your hard-earned retirement savings should not be pilfered by the IRS. However many soon-to-be retirees, and dedicated savers, are unaware of IRS distribution requirements. The penalties associated with failing to comply with these requirements can become a tax trap and cut a significant hole in a retirement account.
What are required minimum distributions (RMDs) anyway? If you need to ask this question, this article is a must-read. Here’s the information you need to keep your money where it belongs – in your own pocket.
The IRS imposes a minimum amount of money that must be withdrawn from a retirement account each year once you hit age 70½. This minimal withdrawal typically applies to IRAs and other IRA-based account types such as SEP IRAs and SIMPLE IRAs. It also applies to many employer-related retirement plans such as 401(k), 403(b), and 457(b) accounts. If the withdrawal is not made by the deadline, you will be subject to high tax penalties in addition to ordinary income taxes.
No Wrath for Roth Owners
It is important to note that RMDs do not apply to Roth IRAs. Roth owners are an exception and escape the tax wrath of the IRS. Because you contribute to a Roth account with after-tax dollars, the total amount, including any earnings from your contributions, can remain in the account with no withdrawals required.
Should you choose to withdraw any contributions, you can do so, tax-free. Alternatively, you can choose to leave the money to heirs, but your heirs will be subject to RMDs.
In the year you turn 70½, you’ll start the clock on taking your annual RMD. For that first year, you’ll have to begin taking money from your retirement account before April 1 of the following year, unless you haven’t yet retired. There is one caveat; if you are a five percent or more owner of the business sponsoring the retirement plan, RMDs must begin once you turn 70½, even if you haven’t yet retired, and not wait until the next April 1st.
If you turn 70½ in 2017, be aware that the RMD you take before April 1st of 2018 is for the tax year 2017. On or before December 31st of 2018, you will have to take another RMD, this time for tax year 2018. In subsequent years, withdrawals must be made by December 31st. The huge tax penalty for not doing so is 50 percent of the amount of the RMD, on top of the ordinary income taxes you pay on the withdrawal.
How Much Do You Need to Withdraw?
The IRS has tables to help you calculate the RMD amount for each year. The tables are based on life expectancies. Typically, you’ll use the Uniform Lifetime Table to calculate your RMD. However, as is often the case with the IRS, there are exceptions. If your spouse is the only beneficiary and your spouse is ten years younger than you or more, use the Joint and Last Survivor Table. If you are the beneficiary of an account (termed an “inherited IRA”), use the Single Life Expectancy Table to calculate how much you need to withdraw.
If this all seems complicated and confusing, fear not. You can always rely on your account custodian (Fidelity, TD Ameritrade, or Schwab for Republic clients) to help you calculate the RMD amount. In fact, the IRS requires your custodian, as an IRA trustee, to report the RMD amount to you or at least to offer to calculate it. However, it’s important to note that the IRS holds you responsible for ensuring the right amount is withdrawn.
Total Withdrawals Can Come from Any Account
Although the amount to withdraw must be calculated for each account, the total amount can actually be taken from any account. This applies to IRAs and 403(b)s. However, the IRS never wants to make your life too simple so, just to make sure you’re on the ball, RMDs from 401(k) and 457(b) plans must be taken separately from each of those plans.
The Good News
Although you’re required to make annual RMDs once you cross the age 70 ½ threshold, you’re not forced to spend it. Your withdrawals can always be invested elsewhere after you incur the required income taxes. Although you cannot take your RMD money and roll it over into another tax-deferred account, you can put your withdrawal into a taxable brokerage account or reinvest it somewhere else of your choosing.
So, who says retirement is for the tired and jaded? It can be full of tax excitement and exhilaration with new financial investment to boot! What’s more, the IRS is encouraging you. Just make sure you consult a financial advisor before you take any unnecessary risk with your hard-earned retirement savings. Remember, we’re always here to lend a hand toward your financial success.
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