Required Minimum Distributions
Required Minimum Distributions Basics
by Stan Corey
It is the time of the year for those who have reached age 70-and-a-half in 2019 to look at making their first Required Minimum Distribution (RMD) from their retirement accounts. Here are the basics that you need to know to make the decision on when to take your RMD. This information also applies to those who are older and have already begun taking RMDs from their retirement accounts. These include traditional IRAs, SEP IRAs, inherited IRAs (special rules apply), and 403(b) plans. You can calculate the RMD for each account or just take the total amount of all accounts to make the RMD calculation. You can take a withdrawal from each separate account or choose to take the total RMD from one account. Note that 401(k) and 457(b) qualified retirement plans must be calculated separately and a separate withdrawal from each is required.
Your first RMD gives you two options, depending on your income tax liability and cash flow needs. IRS requires you to take at least the RMD or you will face a severe penalty of 50 percent of the amount of the shortfall. In the first year, however, you can either take the RMD in the year you turn age 70-and-a-half or defer up to April 1 of the following year. By doing so you will be making two withdrawals in the year you deferred, one for tax year 2019 and one for tax year 2020. In making the decision to defer or not, you should calculate your income tax liability for each option. If you are employed in 2019 and will be retiring at end of the year or in 2020 or if you are working at a reduced pace with lower income, then a deferment may be a good option. You need to know if the total amount of income in each year will move you into a higher tax bracket by taking the RMD. If in doubt, seek professional guidance to make this determination.
There is also much talk about only taking the RMD and not withdrawing more than that amount. This is only a good choice if you have sufficient resources to be able to maintain your standard of living while only withdrawing the RMD. For many people, the retirement accounts represent the major resource for retirement income, along with social security, so withdrawing a greater amount may be necessary.
The RMD initially is based upon the IRS tables for life expectancy and can be calculated using the tables found at their web site: https://www.irs.gov › pub › irs-tege › jlls_rmd_worksheet
In the first year the RMD is only 3.64 percent and increases slightly each following year. The table takes you up to age 115. The reason for the IRS to require distributions is simple: they want you to pay taxes! And you may always withdraw more than the required amount.
The beneficiary designation of an IRA or other retirement plan can make a big difference in when RMDs begin. Note that it is imperative that you have a living beneficiary in order to allow for the continuation of RMDs going forward and not as a lump sum, which may create significantly higher income tax liability if the owner dies before reaching the required beginning date. For spouse beneficiaries, there are several choices, from taking it as their own spousal IRA and take RMDs based upon their own age, to choosing to take RMDs based upon the deceased owner’s age at the time of death. If the spouse has not reached the required beginning age, they may defer taking the RMDs until they do reach that age.
Non-spouse beneficiaries (children or other family members) must take RMDs even if they are younger than 70, based upon table 1 of IRS publication 590-B. The beneficiary must begin taking the RMD by the end of the year following the year of death of the owner, using the younger of the beneficiary’s age or the owner’s at the time of death. If there are multiple beneficiaries for one account, then the age of the oldest beneficiary is used to determine the RMD for all beneficiaries. If you want to obtain the best benefits for all of the beneficiaries especially if their ages differ greatly, you can establish separate IRAs with each individual as a beneficiary so that they will take RMDs based upon their own age.
Another factor is how to determine the amount to withdraw that will provide lasting income for as long as you live. A simple general rule I use is based upon your age assuming normal life expectancy and average annual returns of four percent; at age 70, keep the withdrawal to five percent or less; age 75, keep it to six percent or less; age 80, keep it to eight percent or less; and age 85 and older, to be determined by needs at that time. If you have extenuating circumstances such as health issues that will likely reduce your life expectancy, then you may need to increase the withdrawal rate to meet your needs. Consider looking at all of the resources you have in retirement and determine where to make withdrawals that will provide a balance between after-tax accounts and taxable accounts.
The goal is to minimize overall taxes that will preserve resources for the long term.
Lastly, just remember, if you do not go first class then your kids will! Enjoy your retirement!
Photo credits by retirementliving.com and goalcast.com.
