The RMD boom is upon us.
Starting in 2016, the first wave of Baby Boomers (those born from 1946 to 1964) turned 70½, meaning they were introduced to RMDs: required minimum distributions. RMDs apply to tax-deferred retirement savings accounts such as 401(k)s, 403(b)s, and traditional IRAs.
When you take an RMD, the IRS finally collects its share of the money that’s been growing tax-free through the years. According to at least one estimate, Boomers have roughly $10 trillion in tax-deferred savings accounts.
It’s important to understand how RMDs work because the rules can be complex, and failure to follow them could result in big penalties.
At the risk of sounding repetitive … the RMD clock starts ticking when you turn 70½. RMDs must be taken by December 31 each year – with one exception. To make it fair for people born in the latter part of the calendar, the IRS gives everyone until April 1 of the year after they turn 70½ to take their very first RMD.
For example, retired talk-show host David Letterman turns 70½ on October 12, 2017. He can take his initial RMD by December 31, but he has until April 1, 2018, to satisfy IRS requirements. If Dave waits to take that first RMD between January 1 and April 1, 2018, he will still have to take another RMD before December 31, 2018.
It’s important to remember that the April 1 grace period is a one-time deal. Beyond that initial exception, RMDs must be taken by December 31 every year.
50% The penalty for not meeting an RMD deadline. That means a $10,000 penalty if the RMD for a given year was supposed to be $20,000.
Missed an RMD? There’s a form for that.
If you fall short of taking your RMD by December 31, IRS Form 5329 allows you to request a waiver of the 50% penalty. Think of it as “the dog ate my homework” form. The IRS may waive the penalty if the oversight was due to reasonable error and you are taking steps to remedy the problem. Keep in mind that if the IRS denies your request, you will owe interest on the portion of the penalty you didn’t pay because of the waiver request.
Doing the math
The IRS has provided charts to help you calculate your RMDs as you enjoy life past 70½. Annual RMDs are based on the account value on December 31 of the previous year. To calculate your RMD, divide your account value by the factor that corresponds to your age in the uniform chart below. (There is a different joint-life chart for account owners whose spouse is the sole beneficiary and is more than 10 years younger.)
Some of the possible benefits of consolidation
According to the Bureau of Labor Statistics, 3.7 million Americans 70 or older were employed in 2016. If you’re contributing to a 401(k) or 403(b) account for an employer while working for them when you turn 70½, those accounts are not subject to RMDs.* The exemption doesn’t apply to retirement accounts with previous employers or traditional IRAs, so it might make sense to consolidate your accounts if you want to avoid RMDs. You’ll have to take the initial RMD, but you can roll the remaining balance into your current workplace plan (if allowed by the plan administrator).
* This does not apply if you own 5% or more of the business where you work. You must also work the entire year to be exempt from RMDs.
QCD equals RMD: Donate to charity
If you have to take an RMD from an IRA, a qualified charitable distribution (QCD) can be an effective way to take the RMD and lower the tax hit. The IRS allows you to satisfy up to $100,000 of your RMD if you make a donation to charity, but the money must transfer directly from the IRA trustee to the charity. If you want to use money from a 401(k) or 403(b) account for the QCD, you must roll those assets into an IRA first.
While RMDs are a valuable source of retirement income for many people, others might not need the money right away. Here are a few other options to consider:
• Reinvest the RMD – Enjoy potential for market growth
• Buy life insurance – Establish a legacy for heirs
• Eliminate the RMD – Roth IRAs aren’t subject to RMDs. Converting a traditional IRA to a Roth will be subject to taxation, but eliminate RMDs going forward.
I’ll take “Aggregation for $200, Alex”
Just when you thought it was safe to go back into the water, there’s another wrinkle to RMDs: aggregation. If you have multiple IRAs, the IRS treats the money in those accounts as one big IRA, and your RMD will be determined by that “aggregated” pool of money. For example, if you have five IRAs worth a combined $500,000 on December 31, the RMD for the following year would be $18,868. That money can be taken from a single IRA or multiple IRAs, as long as the total distributions equal at least $18,868. This also applies to 403(b)s.
Things to Consider:
• If you’re nearing your 70th birthday, mark the date when you’ll turn 70½
• If you’re still working, see if it makes sense to roll existing IRAs into your employer-sponsored retirement plan
• Consult a financial professional who can help you understand how your decisions can impact your overall retirement strategy.
Neither Transamerica nor its agents or representatives may provide tax, investment or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.