Required Minimum Distributions

Required Minimum Distributions — The Required Price of Postponing Your Taxes

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Required Minimum Distributions — The Required Price of Postponing Your Taxes

Many retirement accounts, such as traditional Individual Retirement Accounts (IRAs) and employer-sponsored retirement plans like 401(k)s, allow you to postpone paying taxes on the money you contribute and on any investment earnings until you start taking withdrawals. That’s why these are called tax-deferred accounts. The IRS provides this benefit as a way to help you save for retirement. They also know they will eventually get those deferred tax dollars from you thanks to a regulation called Required Minimum Distributions, or RMDs.

After age 70½, you must take a RMD from each tax deferred retirement account you own.

When RMDs kick in

The whole point of tax-deferred retirement accounts is to accumulate money for retirement income. When you take money out of these accounts, ordinary income tax is due on the withdrawal. Remember if you take the withdrawal prior to 59½ a 10 percent penalty will typically apply. If you don’t need to take withdrawals, you can leave your money in the accounts for continued growth potential.

The IRS requires you to begin taking annual withdrawals from your taxdeferred accounts in the year in which you turn 70½. You can withdraw as much as you want, but you must withdraw at least the RMD amount by April 1 of the year after you turn 70½, whether you need the money or not. You must take a RMD from each type of tax deferred retirement account you own.

Example:

Ellen will be 70½ in September 2012. She must take her first RMD by April 1, 2013.

How is my RMD calculated?
Since Derek had $373,000 in his account and a life expectancy factor of 24.7, his RMD for 2013 would be $15,102.

How is my RMD calculated?

Each year, the aggregate balance in each type of account, as of December 31, is divided by a life expectancy factor based on your age, according to the Uniform Lifetime Table. The solution to this simple math calculation is your RMD in dollars.

Example:.

  • Derek has $373,000 in his 401(k) on December 31, 2012.
  • Derek will celebrate his 73rd birthday during 2013.
  • Based on the Uniform Lifetime Table, his life expectancy factor is 24.7.
  • $373,000 ÷ 24.7 = $15,101
  • Derek’s 2013 RMD for his 401(k) account is $15,102

 

Derek would run this same calculation on all of his tax-deferred accounts and would take a RMD from each type of account, each year.

A few tips

  • Create a plan — Your RMD is the minimum you must take out. Create a withdrawal strategy to make sure you are taking out enough to meet your total retirement income needs, but not so much that you will deplete your accounts too soon. Some retirement accounts offer automatic RMD plans so you don’t have to do the math.
  • Consolidate multiple accounts — Since you need to calculate your RMD every year, consider consolidating your retirement accounts to simplify the process. This will help reduce the chance for errors.
  • Reinvest unneeded RMDs — If you don’t need the income from your RMD, you can reinvest it in one of your taxable accounts for the potential to provide additional investment growth.
  • Work with a tax pro — It may be a good idea to consult with a tax advisor to make sure you have your RMD calculated correctly. If you fail to take your RMD or miscalculate and do not take enough, you’ll owe a penalty of 50 percent of the RMD. This penalty is in addition to the ordinary income taxes on the withdrawal. The rules for beneficiaries are even more complex.

Know the requirements

RMDs are a fact of tax-deferred life. If the process seems a little intimidating, talk with a tax accountant and a financial professional to make sure you’ve got all the bases covered.

CN0411-2093-0514