Whether or not you’re ready to start drawing retirement, IRS rules require anyone who owns a traditional IRA or participates in an employer retirement plan, such as a 401(k), to start pulling out their money at age 70½. It pays to know the ins and outs of those withdrawals — called required minimum distributions, or RMDs.
Or, I should say, it can prevent you from paying. That’s because there’s a 50% penalty for not taking out your RMD, or taking out too little. The math is pretty easy. Forget to make a $10,000 RMD and you pay a $5,000 penalty. Ouch.
Over the years, the rules have been simplified, but RMDs remain a source of confusion for some investors. These six concepts are worth keeping straight:
The beginning date can be delayed. Leave it to the IRS to make something seemingly simple as a start date confusing. You can take your first RMD the year you turn 70½ (I’m not sure who chose 70½ as opposed to 71) or as late as April 1 of the following year. Remember, though, if you delay into the next calendar year, you’ll be forced to make two RMDs that year.
Employer retirement plans have their own start rule. While IRA RMDs always start at 70½, you can delay RMDs in employer retirement plans until you quit working, as long as the plan is from the place where you’re still employed. The RMDs from those plans must begin no later than April 1 following the calendar year you retire.
RMDs can’t be rolled over to a Roth IRA. Folks often ask me if they can satisfy RMD requirements by rolling over money they remove from a traditional IRA or 401(k) into a Roth. Their thought: I’m paying taxes anyway; why not put the money into an account that doesn’t have RMDs and offers the potential for tax-free withdrawals? This would be a good idea — if it were allowed. Anyone at any age can convert money into a Roth (and pay taxes on it), but that amount would need to be above and beyond what they took out to meet the RMD requirement.
The implications go beyond income taxes. The point of the RMD system seems to be to allow Uncle Sam to collect the taxes created when you withdraw. However, in your distribution planning, it’s important to remember RMDs mean increased income and that can boost Medicare premiums, result in taxation of Social Security benefits and even reduce or eliminate eligibility for any number of needs-based programs. Taking the long view of all the implications of that increased income is critical.
Be careful where you pull from. This can be tricky. You’re not required to take RMDs from all your IRAs individually. You may calculate the RMDs individually and pull the total amount out of any or all of the IRAs. However, money withdrawn from an IRA does not satisfy the RMD requirement for a 401(k) or other employer retirement plan. RMDs for those types of accounts must be calculated and withdrawn separately.
You can’t pay it forward. This may seem pretty straightforward, but people have asked me if they can pull money out today and use it to satisfy future years’ RMDs. Nope. That’s not permitted under the rules. Of course, anything you pull out today would reduce the account balance and thus future RMDs, but you can’t use something withdrawn today to meet a future RMD requirement.
Don’t put your earplugs in and get caught short making your RMDs. Make a note on your calendar, set up a reminder on your computer, fill out the forms to automate your withdrawal, but don’t forget to make your required minimum distribution(s) this year.
If you do, the IRS will let you hear about it in a big way.