Retirement On Approach

How Well Do Your Clients Understand Their Options For Taking RMDs?

Compare these 2 deadline options and their tax implications before withdrawing your first RMD

A consumer-focused primer for those approaching age 70 1/2, from Fidelity Viewpoints. Reprinted with permission. Visit here.

IRAs and other types of tax-deferred retirement accounts were designed to encourage Americans to save for retirement. At age 70½, you switch gears because you’re required to start withdrawing a certain amount from your retirement accounts each year. That amount is called a required minimum distribution (RMD).

You don’t have to take RMDs from a Roth IRA. However, if you have inherited a retirement account, such as a Roth IRA, you have to follow a different set of RMD rules.

Your RMD amount is calculated by dividing your tax-deferred retirement account balance as of December 31 of last year by your life expectancy factor. If you own more than one IRA, your RMD must be calculated separately for each account, but you can withdraw the total of all your RMDs from a single account or any combination of IRA accounts.

The IRS has specific rules around RMDs, including how to calculate them and the timing for when to take a distribution. It’s important to understand the rules because the penalty for a missed RMD is 50% of the amount not taken on time.

Keep in mind that the IRS taxes RMDs as ordinary income. This means that withdrawals will count toward your total taxable income for the year, which may push you into a higher tax bracket. Being pushed into a higher tax bracket may impact the taxes you pay for your Social Security or Medicare. Be sure to talk to your tax advisor about taking your first RMD.

RMD rules and how they’re calculated

  • RMD rules apply to tax-deferred retirement accounts:
  • Traditional IRAs
  • Rollover IRAs
  • SEP IRAs
  • Most small-business accounts (Keoghs)
  • Most 401(k) and 403(b) plans

Deadlines for your first RMD

The deadline for taking your RMD is December 31 each year. For your first RMD, and only your first, you may delay taking a distribution until April 1 of the year after you turn 70½.

For example, if you turned 70½ in June of this year, you have 2 choices:

  • You can take your first RMD by December 31 this year
  • You can delay taking your first RMD until April 1 next year (the year after you turn 70½)

If you choose to delay, you’ll have to take your first and second RMD in the same year, which may push you into a higher tax bracket.

If you’re still working, you may qualify for an exception from taking RMDs from your current employer-sponsored retirement account, such as a 401(k), 403(b), or small-business account. If you meet all of the requirements, you can delay taking an RMD from the account until April 1 of the year after you retire.

Knowing your options

To understand how delaying your first RMD impacts your taxes and future RMDs, review your options and consider speaking with your tax advisor.

The examples below outline 2 options for you, as a hypothetical retiree:

  • You will turn 70½ this year
  • You have $300,000 in a Traditional IRA
  • Your life expectancy factor for this year is 27.4 based on the IRS Uniform Lifetime Table for someone age 70 years old
  • For the purposes of this example, assume the value of your IRA remains constant

Considerations for option 1:

  • Your account balance was higher when your second RMD was calculated because you didn’t take out your first RMD
  • Your second RMD is $413.75 more
  • Your taxable income for one year would be 2 RMDs totaling $22,269.75 which will more likely push you into a higher tax bracket

Considerations for option 2:

  • Your first and second RMD amounts are the same ($10,949.00)
  • Your taxable income would only be one RMD ($10,949.00) per year, which still has the potential to push you into a higher tax bracket, but not as likely as option 1
  • To determine which option is best for you, talk with a tax advisor about your personal tax situation.