3 Investing Facts About Required Minimum Distributions You Need to Know - June 05, 2020
Failing to withdraw a required minimum distribution (RMD) from your own or an inherited IRA by the deadline results in a big tax code penalty: 50%. That's right. If you were supposed to take out a minimum of $4,000 and (oops!) did not do so, you have the privilege of writing the IRS a check for $2,000. It's important to remember that the rules related to RMDs changed on January 1, 2020
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 Kimberly-Clark (KMB).
But that's just half of retirement planning. The second part, the "distribution phase," sometimes gets overlooked even though it can be more fun to think about. That's because the distribution phase is where you determine how to spend your hard-earned assets.
Planning for the distribution phase is the time where you may make decisions about where you'll want to live in retirement, whether you'll want to travel, hobbies you may pursue, and other decisions that will affect your retirement spending.
In addition to these considerations, it is essential to take into account the RMD that applies to most retirement accounts. Basically, this is an IRS requirement that you withdraw a certain amount from your qualified retirement accounts once you reach age 72.
Why does the IRS require you to start taking your money out? It's simple - they want to make sure they get their tax. If this rule didn't exist, people could live off other income and never pay tax on their retirement investment gains. Then, that money could be left to family or friends as an inheritance without the IRS collecting any taxes from you.
Key Facts to Know About RMDs
What types of retirement accounts have RMDs? Qualified retirement accounts such as 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 happens if I don't take my RMD? The penalty for not taking a required minimum distribution, or not taking a large enough distribution, is a 50% tax on the amount 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.
Example: Ann is 71 and must take her first RMD in the year following the year she reaches age 72. Her year-end IRA balance the prior year was $100,000. Her "distribution period" factor is 27.4. The result of dividing $100,000 by 27.4 is $3,649.63 - the amount that Ann must 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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