Strategies for Retirement Account Distributions
Once you retire, you generally can’t leave the money you’ve been squirreling away sitting in your retirement accounts. You will need to start withdrawing it at regular intervals by taking distributions. In fact, Uncle Sam requires that you withdraw a minimum amount annually on time or you face stiff penalties unless you meet certain exceptions.
Keep in mind that while your retirement plan administrator will typically calculate your required minimums for you, it is ultimately your responsibility to ensure you are withdrawing the correct amount. You can always withdraw more than the minimum, but you can’t withdraw less without penalty. If you fail to meet the deadline or you don’t withdraw enough, the amount not withdrawn can be taxed at 50%, so it’s important to understand what’s required of you and plan for it.
What is an RMD?
You may often hear the term RMD when talking about taking distributions from your retirement accounts. But what is an RMD exactly? RMD stands for required minimum distribution and it is the amount that you must withdraw from your qualified retirement plan to avoid penalties. Why does the government require that you take an RMD? Simply so that they can begin collecting taxes on those dollars that you were allowed to put away tax-free all those years.
When Do RMDs Begin?
The RMD rule takes effect starting the year in which you reach age 70 ½. In the year after you turn 70 ½, you must take your first RMD by April 1 of the following year. Your second RMD and all subsequent RMDs need to be taken by December 31 each year.
If you are still working at age 70 ½, and you are not a 5% owner of the company, you may be able to delay your RMD from your current employer plan until April 1 of the year after you retire. You will need to check with your plan administrator to see if your plan allows this. You will need to take your RMDs from plans sponsored by previous employers and from any IRAs.
What Types of Retirement Accounts are Subject to RMDs?
Specifically, the RMD rule applies to traditional IRAs, SEPs, SARSEPs, and SIMPLE IRAs, as well as your employer-sponsored retirement plans, including 401(k) plans, Roth 401(k) plans, 403(b) plans, 457(b) plans, and eligible profit-sharing plans. If you contributed to a 403(b) prior to 1987, you’ll want to look into the rules that apply to your plan. If your account is a Roth IRA, you are not required to take withdrawals; your beneficiaries—other than a surviving spouse— will be required to withdraw the funds after your death.
How Are RMDs Calculated?
Your RMD amount is calculated based on dividing the balance of your account on December 31 of the prior year by your life expectancy factor, according to the IRS’s “Uniform Lifetime Table.” There is also a separate table used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner. You can find worksheets on the IRS.gov website to help you calculate the RMD for your personal situation.
If you have more than one retirement account or multiple types of accounts, you will need to take more complexity into consideration. The RMD should be calculated for each separate account, but in some cases, you can take the full distribution from one account at a time. For some types of accounts, such as the popular 401(k), the distribution must be taken separately, so be sure to look into how the rules apply to your particular retirement account portfolio.
What About Taxes?
With a traditional IRA, the money you contribute goes in before tax, lowering your taxable income in the current tax year. Then, when the time comes to take money out in retirement, your withdrawals are taxed as ordinary income. Although you are probably looking forward to paying lower taxes during retirement, that doesn’t mean you won’t be taxed at all. Your RMD will be taxed at your income tax rate for the amount of the withdrawals.
Retirement Distributions Strategies
Your financial planner can help you get crystal clear on your numbers, show you savvy strategies to whittle down your taxable distributions, and effectively manage distributions in light of your overall investment income at retirement.
For example, you might benefit from converting your traditional IRA into a Roth IRA, which will lower your RMD amount. Remember, there’s no RMD for Roth IRA accounts if you are the original owner.
You might also consider looking into a qualified longevity annuity contract, or QLAC, which allows you to carve out the lesser amount of up to $130,000 or 25% of your retirement account balance, and invest it in a deferred income annuity.
You may even consider transferring shares to a taxable brokerage account with investments such as municipal bonds or exchange-traded funds rather than taking a cash distribution.
Other options include using your RMD to make a qualified charitable distribution (QCD) that you can write off or funding your grandchildren’s 529 college savings account or Roth IRA for Kids account.
If you’re not able to reduce your required minimum distribution or avoid it, your financial advisor can help you look for ways to make the most of your RMD by making investments and building it into your cash flow as a source of income, especially if your living expenses are already covered by other sources. You can even have your RMD withheld to cover your entire tax bill on your total income sources.
As you can see, although the government forces you to withdraw the funds from your retirement accounts, you have plenty of options for how to handle your distributions and make them work in your favor for whatever your circumstances and goals are.
Now that you know more general information about required minimum distributions, you can begin to prepare for your specific situation with confidence. A financial advisor can help you make smart decisions about your overall retirement income while taking your RMD into consideration. It doesn’t have to be as scary or complicated as it may seem.
John J. Diak, CFP® is the Principal & Client Wealth Manager at Oatley & Diak, LLC in Parker, Colorado. He assists clients through many difficult lifestyle changes such as business downturns, retirement planning, divorce, the death of a spouse, and family estate issues among others. Oatley & Diak, LLC is a family-run registered investment advisory (RIA) firm that provides clients with investment management and financial planning services in a hands-on, intimate environment. Learn more about them at oatleydiak.com.
Content in this material is for general information only and is not intended to provide specific legal advice or recommendations for any individual.
The information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
No strategy assures success or protects against loss. INvesting involves risk including loss of principal.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investment as taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
Traditional IRA account owners should consider the tax ramifications, age, and income restrictions in regards to executing a conversation from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
The Roth IRA offers tax deferral of any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficary’s home state offers and state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals use for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.