By Marguerita Cheng
Every year you enter a new decade is a cause for celebration. Turning 70 is no exception.
For some, turning 70½ is another milestone, because that is when they must start taking required minimum distributions (RMDs) from their traditional, SEP, SIMPLE IRA or qualified plan participants. Roth IRAs and other post-tax accounts do not require distributions until after the death of the owner. Withdrawals or distributions can be taken without penalty once you've reached retirement eligibility.
When you turn 70½, the IRS requires you to take your RMDs starting no later than the following April 1, even if you are still working. This means if you turned 70½ by April 1, 2019, you will have had to take your first distribution by April 1, 2020. If you turn 70½ after April 1 of this year, you won't have to take your first withdrawal until April 1, 2021. All subsequent years require that the distribution be made by Dec. 31. (Note: There is an exception to this rule, which I will explain at the end of the article.)
Not only are you required to take these distributions, or face a stiff penalty if you don't, you also have to calculate your required minimum distribution yourself. If you have a custodian for your IRA account(s), they can calculate the RMD amounts for you to use but it might be worthwhile to do the math yourself as well. Mistakes can happen, and if you don't take the required RMD amount, you will be subject to fines.
According to the IRS website, "If an account owner fails to withdraw a RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%." A separate form (form 5329) will have to be filed with that year's income tax return, and the penalty paid at that time. If you have a reasonable explanation for why the penalty should not be enforced, you can send a letter of explanation along with the form for consideration but there are no guarantees your waiver will be accepted.
Don't let this happen to you. The IRS provides a worksheet that will help you calculate your required minimum distribution amount. We help our clients with this worksheet, check with your financial or tax professional to see if they will assist you.
This worksheet will need to be filled out for each IRA or qualified plan you have. If you are doing the calculations yourself, make sure you pull your statements to find out the exact amount in each account as of December 31 of the prior year for accurate calculations. Follow these steps:
Find the amount of your first account and enter it into the first field.
Find the age you will be on your birthday of the distribution year on the lifetime chart in the worksheet and enter the Distribution Period number in the second field.
Divide line 1 by line 2 and you have now calculated your RMD amount for this account.
Continue this process for each account that is subject to required minimum distributions.
If your spouse is more than 10 years younger than you and is the sole beneficiary of your IRA account(s), there is a different life expectancy table to use to calculate your RMD amounts. If your calculations are coming from your custodian, make sure they know your spouse's date of birth so they can use the right table and worksheet.
If you have a spouse who is more than 10 years younger than you as your sole beneficiary, this is the worksheet to complete. Here's how:
Find the ending amount of your first required account and enter it in the first field.
Enter the age you will turn this year in the second field.
Enter the age your spouse will turn this year in the third field.
Using Table II (found more than halfway down the page), enter the life expectancy figure at the intersection of both ages.
Divide line 1 by line 4 and that number will be your required minimum distribution for that account.
Continue this process until you've completed all accounts subject to RMD.
Congratulations. You've now calculated your RMDs for each IRA and qualified plan account.
As noted on the worksheet, once you've calculated the total minimum amount needed to withdrawal, you can choose to take the amount from one or more of your traditional IRA accounts. The key is to withdraw at least the total figure for all accounts to avoid any penalty.
For example, if your RMD amount is $5,000 and you have 3 different IRA accounts, you can take $5,000 from one account or you can choose to take $1,000 from account A, $1,500 from account B and $2,500 from account C. The amounts from each don't matter as long as the total amount is at least $5,000.
This also might be a good time to confirm your beneficiary designations. The beneficiary listed on your retirement accounts and life insurance policies supersede your will, so it is important to review your policies to make sure the right person is listed -- especially if this is a second marriage and your ex-spouse was listed as beneficiary.
You can choose to take more than the required minimum distribution but remember that you will be taxed on the total amount that you withdraw. This is because, while funding your traditional, SEP, or SIMPLE IRA, you were able to lower your overall taxable income during your working years based on the contributions you made. Now that you are taking withdrawals from the account(s), you will have to pay taxes on the amount each year.
Knowing your marginal tax rate can help you calculate the approximate tax you owe. If you are unsure of your marginal tax rate or how to accurately calculate what you will owe when you file your taxes, speak with your accountant or tax consultant.
Another factor to consider when taking an excess distribution is that you cannot apply that excess to any future years' required minimum distribution. In other words, if your RMD is $5,000 and you take an excess distribution of $1,000 in this tax year, you cannot then take $4,000 next year without experiencing a penalty for taking too small of an amount for the RMD.
Lump Sum Withdrawals
If you don't need your RMD withdrawals to maintain your standard of living, you have another option. You can choose to make a direct philanthropic or charitable contribution.
The new tax laws have dramatically reduced the amount of itemized deductions, which means many will now miss out on charitable deductions. However, you have the option of transferring up to $100,000 annually to charitable organizations.
A qualified charitable deduction, or QCD, provides a benefit in the form of tax-free giving to the organization(s) of your choice. This is not a deduction on your income taxes. Any direct donations from your IRA account(s) are excluded from income, lowering your adjusted gross income for that tax year and lowering your tax bill.
Timing for a QCD is critical. You cannot take a RMD withdrawal and then decide later on that you want to direct the funds to a qualified charity. It must be done as a direct donation from the IRA account(s) to count toward your RMD minimums and not be taxed.
Additional Important Facts
If your loved one has died and left you an IRA that is subject to RMD, you may be subject to a distribution schedule as well.
If you are the spouse and sole beneficiary, you have several options:
- The IRA can be treated as your own;
- RMD withdrawals can be based on your current age;
- Use your spouse's age at death for the base RMD calculations. If you choose this route, you will have to reduce the distribution period by one each subsequent year.
If your spouse died before the required beginning RMD date, you also have the option of withdrawing the entire account balance. If you choose this route, it will have to be done by the end of the fifth year. You do not have to start taking RMDs until the time your spouse would have turned 70½.
If you are the sole beneficiary but not a spouse of the decedent, you have several options. If the account owner died before the required RMD date, you can withdraw the entire account balance by the end of the fifth year;
Using the Single Life Expectancy table, you can calculate RMDs based on the following:
If the account owner died before the required RMD date, use your age at year end the year after the owner died, reducing the distribution by one for every year that passes.
If the account owner died after the required RMD date, you will choose the longer of these two scenarios: Use the owner's life expectancy at death, reducing by one each year thereafter; or use your own life expectancy using the year following the owner's death, reducing by one each year thereafter.
If you aren't sure about tax implications or what the best scenario is for your IRA situation, be sure to check with your accountant or tax adviser who can provide guidance about your specific situation.
Here's the exception to the RMD rule I mentioned at the beginning of the article: If you have reached the age of having to take a required minimum distribution but are still working, there is one instance where you do not have to take the RMD. If you have an employer-sponsored 401(k) or SEP IRA and own less than 5% of the company, you can opt to not take the distribution and can still contribute to the account. Once you leave the employer for any reason, you will have to start taking distributions according to the calculated worksheet.
About the author: Marguerita M. Cheng is the chief executive officer at Blue Ocean Global Wealth. She is a past spokesperson for the AARP Financial Freedom Campaign and a regular columnist for Investopedia and Kiplinger. She is a CFP professional, a Chartered Retirement Planning Counselor, a Retirement Income Certified Professional and a Certified Divorce Financial Analyst. As a Certified Financial Planner Board of Standards (CFP Board) Ambassador, Marguerita helps educate the public, policy makers, and media about the benefits of competent, ethical financial planning.