Abstract: Per IRS rules, people generally must begin taking required minimum distributions (RMDs) from their retirement plans and IRAs (except Roth IRAs) beginning after age 70½. And they must continue taking RMDs year in and year out without fail. This article answers the questions of when to begin taking RMDs, the penalties for not taking them and why it’s best not to wait until year end to take them.
During the course of your career, you may have managed to build up a tidy nest egg, most likely augmented by tax-favored saving devices. For instance, you may have accumulated funds in qualified retirement plans, like 401(k) plans and pension plans, and traditional and Roth IRAs. If you don’t need all the funds to live on, your goal likely is to preserve some wealth for your heirs.
Can you keep what you want? Not exactly. Under strict tax rules, you generally must begin taking required minimum distributions (RMDs) from your retirement plans and IRAs (except Roth IRAs) after age 70½. And you must continue taking RMDs year in and year out without fail. Don’t skip this obligation for 2017, because the penalty for omission is severe.
When should you begin taking distributions?
RMD rules apply to all employer-sponsored retirement plans, including pension and profit-sharing plans, 401(k) plans, 403(b) plans for not-for-profit organizations and 457(b) plans for government entities. The rules also cover traditional IRAs and IRA-based plans such as SEPs, SARSEPs and SIMPLE-IRAs. But you don’t have to withdraw an RMD from a qualified plan of an employer if you still work full-time for the employer and you don’t own more than 5% of the company.
The required beginning date for RMDs is April 1 of the year after the year in which you turn age 70½. For example, if your 70th birthday was June 15, 2017, you must begin taking RMDs no later than April 1, 2018. This is the only year where you’re allowed to take an RMD after the close of the year for which it applies. (Keep in mind that delaying the first RMD will result in two RMD withdrawals during that tax year.) The deadline for subsequent RMDs is December 31 of the year for which the RMD applies.
If you’ve inherited a retirement plan, contact us for information on when you must begin taking RMDs. And if you inherited a Roth IRA, be aware that you will be required to take RMDs.
How much is your RMD?
To calculate the RMD amount, you divide the balance in the plan account or IRA on December 31 of the prior year by the factor in the appropriate IRS life expectancy table.
Although you must determine the RMD separately for each IRA you own, you can withdraw the total amount from just one IRA, or any combination of IRAs that you choose. However, for qualified plans other than a 403(b), the RMD must be taken separately from each plan account.
What’s the penalty for failing to take RMDs?
The penalty is equal to a staggering 50% of the amount that should have been withdrawn, reduced by any amount actually withdrawn. For example, if you’re required to withdraw $10,000 this year and take out only $2,500, the penalty is $3,750 (50% of $7,500). Plus, you still have to pay regular income tax on the distributions when taken.
Keep in mind that with the additional income there are other tax issues, such as the net investment income tax (NIIT). RMDs aren’t subject to the NIIT but will increase your modified adjusted gross income for purposes of this calculation and thus could trigger or increase the NIIT. The NIIT might, however, be repealed under health care or tax reform legislation. (Contact us for the latest information.)
Typically, taxpayers wait until December to arrange to take RMDs from qualified plans and IRAs. But that could be dangerous. It’s easy to be distracted during the holiday season and forget about the obligation. Furthermore, it can take several days, if not longer, for trading and settling funds. And haste can lead to errors and miscalculations that could cost you.
A better approach is to take your time. Make arrangements for RMDs well in advance of the December 31 deadline.