If you have an Individual Retirement Account (IRA), you are probably familiar with the term Required Minimum Distribution (RMD). Most people know they have to take RMDs starting at a given age, but they may be a little fuzzy on the details—and that vagueness can be costly. Let’s take a look at some of the dangers of required minimum distributions, and how you can avoid unnecessary loss or penalty.
Do you know when you need to take your first RMD? If you said 70 ½, you’re right—sort of. The deadline for taking that first distribution is tied to that milestone. You must take your first RMD by April 1 of the year following the year you turn 70 ½. So if you turn 70 on June 30, 2019, you turn 70 ½ on December 30, 2019. You must take your first RMD by April 1, 2020. If you turn 70 on July 4, 2019, however, you won’t turn 70 ½ until January 4, 2020. You would need to take your first RMD by April 1, 2021.
So what happens if you fail to take your RMD on time? You pay a stiff penalty. You may have to pay an excise tax of 50% of the distribution that was supposed to be made, but was not.
Let’s say you’ve made your first RMD in a timely fashion, at least as far as the law is concerned, and took that distribution on March 30, 2019 just before the April 1 deadline. You have a year to take your next annual RMD, right? Wrong.
After your first RMD, you must take each subsequent RMD by December 31 of that year. The first one that you took on March 30 was really a deferred distribution from the previous year, 2018. You still need to take your 2019 RMD by December 31, 2019. This means you are taking two distributions in one tax year. Depending on the size of those distributions, which are taxable income, you could be taking a sizable tax hit. What’s more, the income from the second distribution could bump you into a higher tax bracket.
So, although you might have had until April 1 to take that first distribution, you might have been better off taking it at the end of the previous year.
Of course, in order to take your RMD, you need to know what it is, and your RMD is based, in part, on the value of your account.
Of course, in order to take your RMD, you need to know what it is, and your RMD is based, in part, on the value of your account. But account values fluctuate over time, so at which moment do you value your IRA for purposes of calculating your RMD?
If you said, “the date on which you made the withdrawal,” that seems like a sensible answer—but it’s also a wrong one. The value upon which you base your RMD is the value of your account as of the previous December 31. In other words, if you’re calculating your RMD for 2019, you need to use your account value as of December 31, 2018.
We tend to see life as something that stretches out indefinitely before us, but the reality is that each of us has an (expected) expiration date, and with each passing year, that date gets closer. Your RMD is based not only on your account value, but on your life expectancy. So, just as you need to use the right account valuation date to calculate your RMD, you need to use the proper life expectancy for you this year, not the one for last year or the year in which you first took an RMD.
If you have multiple retirement accounts, you need to determine the RMD for each one. If you have multiple accounts of the same type, you can withdraw the RMD for each from the respective accounts, or you can aggregate the total and draw the RMD for all accounts from one of them.
However, this can only be done with retirement accounts of the same type, such as if you have two or more traditional IRAs. If you have, say an employer-sponsored plan account and a traditional IRA, you will have to separately calculate the RMD for each account, and withdraw the right amount from each one.
As you have no doubt concluded from reading these warnings, trying to figure out and comply with RMD rules on your own is fraught with peril. Considering the potential cost of doing it wrong, it’s a worthwhile investment to retain the services of a professional experienced in retirement planning to make sure you’re doing it right. Contact our office today to schedule a consultation.
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