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Monday, June 24, 2019

Understanding RMD Withdrawals




It’s critical to have a firm grasp of required minimum distributions and some related tax strategies that won’t run afoul of the IRS.


Tax-deferred retirement accounts are a great place to tuck away money for your later years. Your dollars can grow without having to pay Uncle Sam, and the power of compounding works to your advantage. But don’t forget that the tax man cometh, and the IRS will be looking for its share of your retirement pot once you turn 70 1/2.

How Soon RMDs Start


Required minimum distributions (RMDs) are the federal government’s way of getting their share of your tax-deferred investment vehicle. Whether you have a traditional individual retirement account (IRA), simplified employee pension (SEP) account or a SIMPLE IRA, you must begin required withdrawals according to the IRS schedule or face stiff penalties. The distribution counts as income for the tax year in which it is taken.

To simplify, we’ll refer only to your traditional IRA in this article. (You paid taxes on your Roth IRA when you put money in the account, so there are no RMDs on a Roth). Check out this publication for IRS rules on all tax-deferred investments.

You have a choice of taking your first withdrawal during the year you turn 70 1/2, or waiting until April 1 of the following year. Then, you must take a specified distribution annually. Some people like to wait until the following year, because they have just retired and their income is substantially reduced the next year. But not everyone should wait until the last possible date for their first withdrawal.

The tax implications could be significant. If you wait to take your first distribution the next year, you will have another withdrawal to make for that year. Taking out two RMDs in one year could kick you into a higher tax bracket, and may create or increase taxation of your Social Security payment. See the sidebar “Your Birthday Determines When RMDs Begin” for further clarification.

Rollovers


You should also note that the first money out of your tax-deferred retirement account in any given year is considered to be the RMD, and it cannot be rolled over. You may choose to take out additional funds after you take your RMD, but whether they are for a 60-day rollover payable to you, a Roth conversion, or any distribution from an employer plan such as a 401(k), 403(b) or a pension, your RMD must be paid out before moving any other funds out of your IRA.

So, if you have funds in your employer’s 401(k) plan, you would have to first take your RMD from the 401(k) before moving the balance to an IRA. 

Your Birthday Determines When RMDs Begin


The month you were born sets the date for your first RMD.

  • Those born in the first six months of the year, from January through June, will usually begin RMDs the year they become 70 years old.
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  • Those born in the last six months of the year, from July through December, will generally start taking RMDs the year they turn 71 years old.

However, it’s not quite that simple. The government allows you to wait to take your first RMD up until April 1 of the year after you turn 70 1/2. But the downside is that you’ll be required to take two RMDs that year, your first RMD and the RMD for that year. 

For example, if Diane turns 70 on February 21, 2019, she will be 70 1/2 on August 21. Diane must take her first RMD in 2019, but she can wait as late as April 1, 2020 to remove the initial amount. However, she will also need to take her second RMD in 2020, and it must be taken by December 31. Both amounts count as income in the year they were taken out of her IRA.

As another example, Tom turns 70 on September 7, 2019. He will be 70 1/2 on March 7, 2020. He will be required to take his first RMD in 2020 but could wait as late as April 1, 2021. However, he will also have to take a second RMD for 2021 by December 31 of that year.

Rollovers


You should also note that the first money out of your tax-deferred retirement account in any given year is considered to be the RMD, and it cannot be rolled over. You may choose to take out additional funds after you take your RMD, but whether they are for a 60-day rollover payable to you, a Roth conversion, or any distribution from an employer plan such as a 401(k), 403(b) or a pension, your RMD must be paid out before moving any other funds out of your IRA.

So, if you have funds in your employer’s 401(k) plan, you would have to first take your RMD from the 401(k) before moving the balance to an IRA.

How to Calculate Your RMD
The IRS RMD Worksheet will work for most account owners. Your married status is determined on January 1 of each year. The worksheet uses the Uniform Lifetime Table to figure out how much you must remove.

If your spouse is the sole account beneficiary and is more than 10 years younger than you, you will make slightly lower RMDs by using the required Joint Life and Last Survivor Expectancy Table. You can use the IRS RMD Worksheet that applies to your special situation.

Use this handy RMD calculator to compute your mandatory minimum distribution from a traditional IRA. Combine the balances of all your traditional IRA accounts on December 31, 2018, but leave out any Roth IRAs. The calculator asks for your primary beneficiary and date of that person’s birth to automatically use the correct table.

As a service to their clients, financial advisors and brokers commonly calculate and even automatically distribute RMDs from their client’s account.

Tip: Remember that the beneficiary or beneficiaries listed on your account(s) supersede a will. If your ex-husband is still the beneficiary on your IRA, he’ll inherit the money. It’s the same for life insurance, so make sure your intended recipient is the one listed on your account.

Penalties and Payments


Should RMDs Start Later?


In the fall of 2018, President Trump asked the Treasury Department to review the rules surrounding RMDs. Updating the life expectancy tables, which was last done 16 years ago when Americans lived on average more than a year less than today, makes sense, although Congress is required to make the change. But few older adults would benefit much from slowing the amount they must withdraw from their IRAs and 401(k)s.

Current RMD requirements combine the life expectancy of the account owner with that of an imaginary beneficiary 10 years younger. This makes for generous assumptions. The life expectancy of someone who is 70 is more than 27 years; that’s far longer than the reality.

The relatively few people with large defined contribution assets used as estate planning vehicles would come out well from such changes. Many are not so fortunate. To meet their living expenses, a lot of retirees with small accounts already withdraw more than the IRS requires. They wouldn’t see any benefit.

Almost half of retirees report less than $100,000 in retirement savings. If 1.6 years are added to life expectancy tables, someone with $137,000 in retirement funds and in the 10 percent income bracket would save $27.60 annually. Hardly a windfall.

At around the same time, the House considered eliminating RMDs on employer retirement plans with balances under $50,000. It seems like a worthy idea, but it wouldn’t make much difference for most account holders. RMDs on that size of account are fairly modest to begin with, and are often depleted to pay for living expenses.


The IRS has waited, sometimes decades, for money from your tax-deferred account. When RMDs are due, the tax agency will make sure you comply by making the penalty so onerous that you dare not do otherwise. If you fail to take distributions, or if the distributions you do take are not enough, you will owe a 50 percent flat rate excise tax on the difference. Ouch.

To take an RMD, you can remove money from any of your traditional IRA accounts in any way you like, as long as it adds up to your RMD. You can take equal percentages from several accounts, or a large amount from one, less from another, and nothing at all from remaining accounts. The IRS doesn’t care, as long as the correct amount is taken. You are also free to take more than the RMD in any year.

Tax Strategies


Many retirees need the money from their RMD for living expenses. However, some individuals with higher net worth or a high proportion of funds in a traditional IRA may not need the entire RMD amount. For these people, it’s important to strategize to keep taxes on the withdrawals as low as possible. Here are some options to discuss with your accountant.

  • You must use all of your traditional IRA accounts, including rollover IRAs, SEP IRAs and SIMPLE IRAs, to calculate your RMD. But you have the option to take the money out of any one or a combination of the accounts. You can choose to remove the money from the IRA that has the highest fees, limited investing options or a concentration in a single stock. You can also trim from accounts to re-balance and maintain your desired allocation.
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  • RMDs in traditional IRAs and 401(k) plans are calculated and withdrawn separately. Each 401(k) RMD must be taken separately as well. If you’re still working when your first RMDs become due, you may be able to wait until April 1 of the year after you quit working to take the RMD from your current employer’s 401(k). If your current employer allows it, you may be able to roll over funds in your other 401(k)s and existing IRA Rollover accounts to your current plan, thus putting off RMD withdrawals.
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  • Make sure your administrator doesn’t automatically withdraw RMDs proportionately from each of your investments. Doing so could cause stocks or funds to be sold at a loss. Usually, you can elect to take your RMDs from cash, and the administrator will send you an alert ahead of time if you need to liquefy assets. 
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  • You can transfer up to $100,000 of income tax-free directly from your IRA to charity each year after you turn 70 1/2. This is called a qualified charitable distribution (QCD) and it counts toward your RMD. The transfer must be made directly from your IRA to the tax-qualified charity. Instead of the IRS taking a share in the form of taxes, the charity gets 100 percent of your money. This includes any church contributions.
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  • Any money you’ve previously rolled over from a traditional IRA to a Roth avoids future RMDs, although you must pay taxes in the year of the rollover. If you roll over a traditional IRA after age 70 1/2, you must take the RMD for that year first.
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  • Money invested in a qualified longevity annuity contract (QLAC) is removed from your RMD calculation. You may invest the lesser of up to a quarter of the balance in your traditional IRA accounts or $130,000. Although it can be done at any age, most invest in their 50s or 60s, and choose to begin receiving payments in their 70s or 80s (but no later than 85). However, if you die before payouts start, you won’t receive a dime, unless you’ve opted for a version. This type of contract offers smaller payouts for you but includes a sum for your heirs if you pass away before your payouts reach your initial investment.
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  • In-kind transfers are permitted to satisfy the RMD. If you have investments in your retirement account that may be difficult to sell, consider transferring them in-kind to a non-retirement account. You will still owe the taxes on the distribution but this option allows you to stay invested in the security. And because you paid taxes, the cost basis on the investment in the taxable account will be reset on the day of the transfer.
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  • If any of your IRA contributions were made with non-deductible contributions, a portion of your withdrawal will be tax-free. You are required to keep track of your tax basis on IRS Form 8606
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Click below for the other articles in the June 2019 Senior Spirit


Sources:

https://www.barrons.com/articles/ira-mandatory-withdrawal-rules-51552058882
https://www.kiplinger.com/slideshow/retirement/T032-S002-11-strategies-for-ira-withdrawals/index.html?rid=EML-today&rmrecid=3620693347
https://www.fool.com/retirement/iras/2018/09/09/2018-ira-rmd-table-how-much-do-i-have-to-withdraw.aspx
https://www.kiplinger.com/tool/retirement/T032-S000-minimum-ira-distribution-calculator-what-is-my-min/index.php
https://www.investopedia.com/articles/retirement/081916/rmd-strategies-how-avoid-drawing-down-money.asp
https://maestrowealth.com/2017/10/27/birth-month-determines-rmds/
https://www.kitces.com/blog/proposal-reduce-rmd-obligation-update-life-expectancy-eliminate-age-limit-50000-threshold/
https://www.forbes.com/sites/howardgleckman/2018/09/07/treasury-should-review-ira-minimum-distribution-tables-but-changes-would-help-few-seniors/#7d5364ec1d33




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