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Your Money Matters

Seniors Face Different Fiscal Cliff at End of Year

By Your Money MattersFOXBusiness

Time’s running out for senior citizens over the age of 70 to make contributions to certain savings plans.

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Grandparents across the country will have a lot less jingle this time next year if they make a major- and common- mistake before the end of this year. The issue? Forgetting to take what’s called their Required Minimum Distribution, or RMD, before the clock strikes midnight on Dec. 31.

Anyone who is 70 years or older and has money in a non-Roth IRA or a defined contribution plan such as a 401(k), 4013(b), 457, etc. is required by law to withdraw a minimum amount each year (1a, 1b).The amount is based upon your life expectancy- either yours alone or the joint life expectancy of you and your spouse.

But like much of the tax code, what appears simple on its face, is more complicated than you think--especially if you’re getting forgetful, are math-phobic or don’t keep good records.

Here’s how to calculate the minimum withdrawal you have to make in 2012:

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The first thing to notice is that your 2012 RMD is based upon what your account was worth at the end of last year so you’ve got to either dig out your 2011 year-end statement or contact your retirement account provider.

The next thing you have to know is your Life Expectancy Factor. This depends upon your age and marital status and it comes straight off an IRS table. You just have to know which table. There are three of them. You’ll find them starting on page 86 of IRS Publication 590.

Use the Single Life Expectancy table if you have inherited someone else’s IRA. The IRA account will still be listed in the name of the individual who died and left it to you. It will be titled along the line of, “Uncle Paul’s IRA; Nephew Jimmy, beneficiary.” In this case, age 70 is not a trigger. No matter what Jimmy’s age, he must begin annual RMD’s no later than Dec. 31 of the year following Uncle Paul's death.

Table II is titled “Joint and Last Survivor.” Use this one if you are married and your spouse is more than 10 years younger than you and is the sole beneficiary of your IRA. First, find your spouse’s age on the horizontal line that runs across the top (you will probably have to scroll through several pages to find the one you need). Once you locate the age of your younger spouse, locate your 2012 age in the vertical column on the left hand side of the page. The box where the two meet is this year’s Life Expectancy Factor.

Most people will use Table III known as the “Uniform Table” to calculate their annual RMD. This applies if:

• You are single, or • Your spouse is less than 10 years younger than you, or • Your spouse is not the only beneficiary of your account

You simply locate your age and use the corresponding “Distribution Period” as your divisor in the equation above.

The last step is to notify your IRA custodian or the administrator of your company retirement plan and request a distribution equal to at least your RMD. Remember: this is just the required minimum amount; you can always take out more.

No big deal? Well, even if you’re a modern day Albert Einstein, have all the information you need and know what your Life Expectancy Factor is, you can’t stop the clock from ticking. Your provider must have your withdrawal processed by Dec. 31.

If you miss this deadline you will get hit with one of the most onerous penalties in the tax code: 50%! If you were supposed to withdraw $5,000 from your account and you forgot, too bad. When the IRS catches up with you, you not only have to withdraw the $5,000 and pay income tax on this, you also need to send Uncle Sam $2,500- half the amount you should have withdrawn.

No one wants to part with more money than they have to, but this big a penalty is especially onerous for seniors living on a fixed income. And, unlike other IRA mistakes you might make, there is little room for leniency.

If you overlooked taking an RMD, the best advice is to take the withdrawal as quickly as possible and fess up. “It’s treated on a case-by-case basis,” says Ken Hevert vice president of personal retirement products at Fidelity Investments. If you realize you forgot to take a required distribution from one of your retirement plans, take your withdrawal as soon as possible. You will also need to attach this IRS Form 5329 to your tax return for the year you take the withdrawal.

The worst thing you can do is to compound your mistake by thinking, “Oh, the IRS will never know.” In fact, every IRA custodian must file an annual form with the IRS for each account owner who is 70 or older that states that year’s RMD amount. It’s a simple matter for the IRS computers to cross-check this. “You won’t get a pass [from the IRS] if you don’t take the distribution,” warns Hevert.

Form 5329 is where you can explain why you forgot to take your RMD. Perhaps your spouse passed away and you were distraught, or you are a victim of Hurricane Sandy and your financial paperwork was lost, or you took a withdrawal from one account, but forgot about another one you own.  It’s also a good idea to talk to a tax advisor. There’s no guarantee the penalty will be forgiven, but the IRS tends to be more understanding if you are forthcoming in admitting your error instead of trying to hide it.

Frankly, why not take the stress out of this annual ritual and put it on auto-pilot?  Virtually every IRA custodian will set up an automatic payment plan based upon your preferences. They’ll even calculate your RMD so you don’t have to worry about the math. My late mother-in-law had her annual RMD sent every year in mid-November.  She used the money like a Christmas club account to buy presents for the family.

“People fall into different categories,” says Hevert. “There’s the individual who earmarks the month of a special milestone, such as at the beginning of the year. They use is to pay taxes.” Others arrange to receive their RMD on their birthday and use the money to treat themselves.

According to Hevert, “Another group recognizes that these distributions are part of their retirement income plan and have them integrated into that.” For instance, they might request that their annual RMD amount be divided up and sent to them in monthly checks. Or, if they have sufficient income from other sources, the RMD withdrawal can be automatically re-invested in other assets that provide a tax break, such as municipal bonds, life insurance, or annuities.

Then there are those who simply forget or get busy. A few weeks before the Dec. 31 deadline, all of a sudden they realize they still haven’t taken their annual withdrawal. This is the majority, at least at Fidelity, which has more than half a million IRA accounts in RMD status. As of early November, 65% of these account owners had still not taken their 2012 distribution.

What’s worse is that many people have retirement accounts scattered among several different providers. They may have left money in the 401(k) of a former employer, have a Roth IRA at a credit union, an IRA at a bank, and another invested at a mutual fund family. This means they have to calculate- and remember to take- an RMD for each account!(2)

If this sounds familiar, why not simplify your life (do you really want to get all of those quarterly statements?) and reduce the chance of making a costly mistake by consolidating whatever retirement accounts you can? IRAs can be combined, 401(k)s and other types of employer plans can be rolled into an IRA. Having all of your pre-tax retirement money in a single account makes it easier for you to keep track of how your investments are performing, eliminates a lot of paper and makes it easier for you or your advisor to re-balance your assets on a regular basis.

Oh, did I mention that this means you only have to remember to take one RMD instead of a bunch of them?

“Equally important,” says Hevert, “is to make sure you have the right mix of investments to reflect this stage of your life.” While it’s common to grow more conservative about your investments as you age, this can be a huge mistake, especially in the current environment of historically-low interest rates. “You need to worry about inflation, rising healthcare costs and longevity,” says Hevert. “When it comes to your nest egg, it’s critical to have the right mix of liquidity and flexibility in the short run and [also be able to] cover your long-term risks.”

If you haven’t taken your 2012 required distribution(s), make this a priority.

If you have to sell securities in your account in order to generate the cash needed for a distribution remember that if your retirement assets are invested in mutual funds, the proceeds are generally available the day after you sell your shares. But individual stocks have a three-day settlement period. This means calculating how many shares to sell, putting in your “sell” order, hoping it fills quickly and then waiting for three days for the sale to settle so that a distribution check can be cut.

You’re pushing your luck if you wait until the last week of December. First of all, this year there is one less trading day because of Christmas. And Dec. 29 and 30 fall on Saturday and Sunday.

Think about this: Unless you completely cash out your account(s) and pay a huge tax bill, will be taking RMDs for the rest of your life.

“Do you want to go through this every year for the next 15-20 years?,” asks Hevert. “Let your IRA provider help you out.” They can help you determine a suitable investment mix, calculate your distribution amount, automatically send you a check or invest the money for you, reduce the paperwork and help you sleep better knowing you will not incur the severe penalty that comes with making a mistake.

If you’ve got a loved one who is 70 or older, why not help them simplify their finance life this holiday? Might be appreciated more than another pair of flannel pajamas.

1a. You get some extra time if you turned 70 in 2012. Technically, the rule is that your first, i.e. Age 70, RMD must be withdrawn by April 1st of the year after you turn 70½. If your birthday fell within the first 6 months of this year, you will turn 70½ before the end of December. Thus, you have until April 1, 2013 to withdraw your first RMD. Just don’t forget that you have to take a second RMA next year. This represents your Age 71 RMD and it must be withdrawn by December 31st. If your 70th birthday fell in July or later this year, you will not turn 70½ until sometime next year. So your first RMD isn’t due until April 1, 2014. Thereafter, your RMD deadline is December 31st each year.

1b. There is some flexibility when it comes to company-sponsored 401(k) plans. If you are 70 or older and still working, your plan might allow you to delay RMDs until you retire (provided you don’t own 5% or more of the company). Check with the person who administers your plan.

2. If you have multiple traditional (pre-tax) IRAs, after calculating each one’s annual RMD, you may take the entire amount from just one of the IRAs if you wish. There are never RMDs from a Roth account.

Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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