If you are retired and have invested in a retirement plan, December 31st is one date that should be marked clearly on your calendar. That’s the last day that you are allowed to make any Required Minimum Distributions, or RMDs, to avoid a steep IRS penalty. In fact, penalties for mishandling these withdrawals are among the most costly penalties in the entire tax code. Here’s what you need to know about handling this year’s RMD.
What are RMDs?
Retirement accounts like 401(k)s and Traditional IRAs delay taxation on your investment gains, which incentivizes you to save more while you are working. But once you retire, the IRS wants to begin collecting on those unpaid taxes, which they can do when you make a withdrawal from your retirement accounts. So, the IRS requires a minimum withdrawal each year – the RMD. (Roth IRAs, which includes tax-free withdrawals, are exempt from the RMD rule.)
If you have a Traditional IRA, you should start taking an RMD – which you will need to calculate – when you turn 70 ½. If you have a work-sponsored plan, such as a 401(k), you should start taking RMDs either when you turn 70 ½ or when you retire, whichever is later. If you do not withdraw your RMD, the IRS will charge you a tax penalty equal to 50% of your RMD amount. For example, if your RMD is $20,000 and you withdrew zero dollars before the January 31 deadline, the IRS will charge you a $10,000 penalty.
How to calculate your RMD
RMDs are calculated using a few different factors. Your particular RMD is based on your current age, the amount of money in your retirement plan, and your expected life expectancy, as calculated by the IRS. The IRS publishes calculation tables every year, known as the IRS Uniform Lifetime Table.
To find your RMD for this year, find the “life expectancy factor” next to your current age on the table. Then divide your retirement account balance (as of December 31of last year) by your life expectancy factor.
For example, if you are 80 or will turn 80 sometime in 2015, your life expectancy factor is 18.7. And if you had $100,000 in your Traditional IRA on December 31st 2014, your RMD calculation for 2015 would be: $100,000/18.7 = $5,348. It’s always a good idea to double check your calculation with your financial advisor.
Special situations for RMDs
1st year of RMDs
In the first year that you take an RMD, you have the option of delaying your withdrawal until April 1 of the following year. So, if you turned 70 ½ in 2015, you can delay your first RMD until April 1st of 2016. But remember that if you do this, you will need to make two withdrawals in one calendar year, the first by April 1 and the second by December 31, in order to stay compliant for next year. Depending on your situation, the extra withdrawal could move you into a higher tax bracket.
If your spouse is more than 10 years younger than you and would inherit your retirement plan, then the RMD calculation is based on a different table, called the “Joint and Survivor Life Expectancy Table.” This calculation table reduces your RMD amount to help ensure there are sufficient funds to support your younger spouse’s retirement.
Multiple retirement plans
If you have more than one retirement plan through your employer, you are required to calculate and withdraw RMDs for each individual plan. However, if you have more than one IRA, you can combine the withdrawal. For example, if you calculate that you must withdraw $1,000 out of one IRA and $2,000 out of another, you can divide those withdrawals across both accounts- however you prefer, as long as you take out a total of $3,000 from all your IRAs.
Inherited retirement plan
The person inheriting your retirement plan will also need to do an annual RMD, should you pass away. If your spouse inherits the plan, they have the option of rolling the money over into their own IRA and following the normal retirement RMD schedule.
If someone besides your spouse inherits your retirement plan, they will need to calculate RMDs based on the single life expectancy table. The inheritor must make RMDs immediately, and are not allowed to wait until their retirement. For example if your 50-year old son inherits your plan, he is not allowed to wait until he turns 70 ½ to begin RMD withdrawals.
You worked hard to save up money in your retirement plans so make sure that money doesn’t slip away to costly penalties.