Created in the Tax Reform Act of 1986, required minimum distributions (RMDs) are set dollar amounts the government mandates you take a distribution from your retirement accounts once you reach the age of 70 ½. Once this age is reached, you have until April 1 of the year following turning 70 ½ to take the distribution from your retirement account or accounts. For each year after, the RMD must be taken by Dec 31. A few details here are important to be mindful of.
1 – Each retirement account has its own RMD. Traditional IRA, SEP IRA, SIMPLE IRA, and all employer-sponsored retirement and profit sharing plans are included. See the IRS RMD Worksheet for more details on how to calculate your RMD. Note: your IRA / Employer-sponsored plan custodian should also be providing you with your RMD amount, but the burden ultimately falls to you
2 – If you are employed when you reach 70 ½, and are not a 5% owner (directly or indirectly) of the company, generally your employer-sponsored retirement plan RMD could be delayed until the year you retire, BUT your corresponding IRA accounts will still have RMDs regardless of being employed. Self-employed individuals usually are unable to avoid this exception.
3 – Roth IRAs do not have RMDs
4 – The penalty for failing to take your RMD may be up to 50% of the amount of the RMD that has yet to be taken
5 – Your RMD is still your money. While your RMD will contribute to your income level for the corresponding tax year, and taxed accordingly, you are still able to move the balance of these funds into a taxable account to either invest or use to support your lifestyle.
6 – You’re able to withhold tax directly from your RMD to help manage tax liability
7 – You may satisfy separate IRA RMDs all from one account, but you may not satisfy Employer plan RMDs with IRA RMDs and vice versa.
Now that we’ve covered some basics, let’s look towards some ideas to consider when preparing to take your RMDs:
Don’t let year of your required minimum distribution sneak up on you! Since you’re able to delay until April 1 of the year following turning 70 ½ this gives us a bit of a grace period. However, if you do delay, you should be aware that you will be taking two RMDs in the same tax year. For example, if you turn 70 ½ in 2019 you have until April 1 to take your 2019 RMD. If you delay taking your 2019 into 2020, you will then be taking the 2019 and 2020 RMDs in the tax year of 2020. Both RMD amounts will then count toward your 2020 taxable income. Will this increase your tax bill? Are you prepared if it does? Remember (listed above) you may withhold tax directly from your RMD, to help manage your tax liability, but it’s important to talk to your financial advisor and tax advisor about these impacts.
Qualified Charitable Distributions (QCDs):
If you already make charitable contributions this may be something to consider. A QCD is a distribution that goes directly from your IRA (not employer sponsored plan) directly to a qualified charity of your preference. While benefitting your preferred charity this strategy could have a significant impact on your taxes while also satisfying RMD requirements. You’re allowed to distribute up to $100,000 annually from your IRA using this strategy; so it is especially worth considering if you are a substantial charitable donor. (See Elaine’s article)
Change Your RMD Amount:
While the IRS has a uniform table that determines the amount of your RMD you may be able to take a little more ownership over the amount they require you must take. Whether you are currently taking an RMD, are soon to be taking an RMD, or are looking to diversify your tax strategies in/near retirement you do have options in managing your RMDs carefully. Converting a portion of your Traditional IRA (or employer plan) to a Roth IRA would help to limit the amount of RMD required year over year, allow for tax-free growth, and even provide tax-free income. By decreasing the account balance, upon a conversion, this would then decrease the amount of RMD you’re required to take as RMDs are calculated based upon account balances. It is important to note that your conversion is a taxable event, so you’ll pay tax on the front end, and the management of your tax liability cannot be overstated. Taking advantage of a year with a low marginal tax bracket could provide a good opportunity to do this. A conversion needs to be carefully managed in order to not create an oppressive or crippling tax liability, so working with an advisor is of paramount importance. Note: RMDs themselves are not eligible for conversion (or rollover) from one IRA to another/Roth IRA, this conversion should be done either prior to or after satisfying your RMD.
While the government created the RMDs to curtail the building of wealth inside tax-sheltered accounts, there are still strategies that are useful for the organized and disciplined investor. The years of age 60-70 provide prime opportunity to both maximize retirement contributions, prepare for tax diversification strategies, and manage income as it pertains to RMDs. Managing your RMDs carefully can create excellent opportunities for thriving in and successfully navigating retirement.
**The information in this article is provided with the understanding that the author is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. As such, it should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisers. Before making any decision or taking any action, you should consult with your own accounting or financial advisor.
JT Trimble, Candidate for CFP® certification, joined YHB in August of 2018 and serves as a Client Account Manager. He is a regular contributor to Let’s Talk Investing and speaker at numerous events throughout the region. JT is a member of the Loudoun County Chamber of Commerce and the Financial Planning Association.