As the oldest baby boomers turn 70 this year be sure to add RMD’s to your retirement vocabulary. Required Minimum Distributions, often referred to as RMDs, are amounts that the U.S. federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans with the first withdrawal due at age 70 1/2.
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Managing RMD’s can be more complicated than most people realize. As you begin the withdrawal process, the decisions you make now can have a tremendous impact on your retirement plan and the amount of taxes you will pay over your lifetime.
Leah Miller, CEO of Red Anchor Wealth Management, explained to FOXBusiness.com what Boomers need to know about RMD’s as they approach the age of 70 ½. Here is what you need to know:
Boomer: If I am turning 70 1/2 in 2016, when do I have to take my first required distribution from an IRA? Does the same apply to a 401K?
Miller: If you turn 70 from January 1 through June 30, 2016, you must take your first RMD by April 1, 2017. If your 70th birthday is from July 1 through Dec 31 of 2016, then you are able to wait until April 1 of 2018 to take your first distribution.
The first year, and only the first year are when RMD’s can be taken as late as April 1, the year after you turn 70 1/2. All subsequent years, it must be taken by December 31 to avoid penalties. The April 1 deadline should not be confused with the deadline for filing taxes, which is April 15 each year.
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ROTH IRA’s sometimes cause a bit of confusion around RMD’s. Some people think that RMD’s do not apply to ROTH IRA’s. This is not entirely correct. You do not have to take RMD’s from your own ROTH IRA during your lifetime; however, if you are a beneficiary of a ROTH IRA, you may be required to take distributions on the money.
Spousal beneficiaries can roll it into their own ROTH IRA account, and thereby treat it as their own ROTH IRA. Non-spousal beneficiaries must either distribute the entire amount by the end of the 5th calendar year after the owners death, or the entire balance must be payable over the life expectancy of the designated beneficiary.
401k plans require RMD’s to be taken at 70 1/2, but with some differences. If you are still working, you are not required to take RMD’s from your 401k plan until the year you retire. The exception is if you are a 5% or more owner of the business that sponsors the plan, in which case you cannot delay RMD’s past 70 1/2.
Remember that if you stave off your first RMD until April 1, you will end up with 2 distributions in the same year. Before making this choice, be certain that it will not push you into a higher tax bracket in the double RMD year. This could cause you to pay higher taxes on your Social Security and all other income for that year.
Boomer: How do I calculate the amount required for my first withdrawal from my IRA?
Miller: The IRS has a worksheet for calculating RMD. It involves the following:
1. Your account balance from Dec 31 of the prior year
2. Your distribution period, found on the IRS Uniform Lifetime Table (for age 70 1/2, the distribution period factor is 27.4)
EXAMPLE: If your qualified plan account balance on Dec 31 of 2015 was $500,000, you would calculate as follows:
$500,000/27.4 = $18,248.18.
This represents approximately 3.7% of the total balance for your first year’s distribution.
Boomer: What are the penalties if I fail to make the withdrawal on time or if I don’t withdraw enough?
Miller: The IRS takes an “off-with-their-heads” approach to those who fail to take their RMD’s. The penalties are stiff, at 50% of whatever you should have taken out, but did not take. Most people who fail to take the full RMD say that it is completely unintentional, but there is no consideration for accidents or miscalculations. It is a 50% penalty, no matter what the intent.
Boomer: How are RMD’s taxed? Is there any way to avoid paying taxes on my distribution?
Miller: Distributions from a ROTH are tax free, but distributions from a traditional plan are taxed at the individual’s current income tax rate.
To avoid taxes you must avoid distribution. This would require proactive ROTH IRA conversions prior to the time for the RMD. Solid planning is involved in making tax advantaged ROTH IRA conversions. I would not recommend doing this without professional advice.
The only way to avoid taxes on your RMD is to buy a one-way ticket to Indonesia, or another non-extradition country. This may not fit with one’s overall retirement plan.
Boomer: If I am still working at 70 ½ and receiving RMDs is my employer required to continue to make planned contributions to my 401K?
Miller: If your employer offers a match, you will still be able to take advantage of the match for as long as you work full time. The employer match combined with the ability to delay RMD can give a nice boost to retirement assets.