July 20, 2016 — The oldest baby boomers, those born in the first post WWII year, are turning 70 this year. To which the IRS is probably saying, “Happy Birthday Boomer”, because the U.S. Treasury is about to get billions in tax presents. That’s about to happen because Required Minimum Distributions (RMDs) from your retirement funds are required in the year you turn 70 and 1/2. To do the math for you, if you were born in 1946 and your birthday is prior to July 1, you will be 70 and 1/2 in 2016.
If that describes your situation, you must start taking your annual Required Minimum Distribution (RMD) from your IRAs and 401(k)s. This year (the year you turn 70 and 1/2) you could wait until April 1, 2017 to take it, but if you do you will also have to take your 2017 RMD by December 31, 2017.
All of the money taken from regular IRAs and 401(k)s is taxable as ordinary income. If you inherit an IRA or 401k you will likely have to take a RMD, even if you are not yet 70 1/2.
How much will my RMD be
The required distribution percentage starts at 3.65% at age 70. Every year you live past that the percentage goes up, reaching 15.87% at age 100. Here is a link to Vanguard’s RMD Calculator Another way to calculate the RMD with the same effect is to use the IRS Life Expectancy Factor and divide your taxable retirement assets by that factor. At age 70 the Factor is 27.4.
You must calculate your RMD on all of your retirement accounts (except Roth IRAs), but you can withdraw it all from one account if you prefer. The company that administers your retirement account will usually help you calculate the amount you need to take out. Amounts in your Roth IRAs are not subject to RMDs.
The penalties for non-compliance are significant. According to the IRS, if an account owner fails to withdraw a RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.
Tax advantages made these programs work
IRAs and 401(k)s have turned out to be a great way to encourage retirement saving. Their tax advantages were appealing and easy to see: the contributions to the plans were tax deductible at the time they were made, and all earnings and capital gains have been tax free all this time. But the intent behind the plans was not to let us enjoy these tax advantages forever. RMDs require that the money in the plans comes out eventually, and everything that does is taxable.
Don’t pay taxes – make a Charitable Deduction instead
You don’t have to pay taxes on your distributions, if you give them to a qualified charity (“qualified charitable distribution” (QCD). For many people this is a great strategy, because they probably would donate to a charity anyway. So instead of donating money from your non-retirement funds and then claiming a deduction, you give from your 401(k) or IRA and don’t have to count the money as income. The donation must be made directly from the financial institution to the charity. The amount of the distribution you donate (you can give all of part of your RMD) will not count as income for your taxes. The RMD charitable tax break was made permanent in 2015. If interested in this strategy, consult with the firm that holds your retirement funds – well before the end of the year!
Text of IRS requirement:
“You must take your first required minimum distribution for the year in which you turn age 70½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31 of the year.”
There are some exceptions which allow some people who have not yet retired to delay their first RMD. See RMD FAQs at the IRS, or your tax professional.
Comments? Have you had any problems calculating your required distributions, or other issues? Please share your thoughts in the Comments section below.