December 6, 2015 — If you have a 401(k) and/or an IRA, and you turned 70 and 1/2 in 2014 or earlier, you have a very big deadline coming December 31. That is the date by which you must take your annual Required Minimum Distribution (RMD), or face significant penalties. A surprising number of people fail to take these distributions. All of the money taken from regular IRAs and 401(k)s is taxable as ordinary income. There is an exception to this rule: the year you turn 70 1/2 you have until April 1 of the following year to make your first distribution (but if you wait until then you will have to take your second distribution by Dec. 31 of the same year). If you inherit an IRA or 401k you will likely have to take a RMD, even if you are not yet 70 1/2.
You must calculate your RMD on all of your retirement accounts, 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. Note: 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fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.
RMD %s change over time
The required distribution percentage starts at 3.65% at age 70 and goes to 15.87% at age 100. Here is a link to Vanguard’s RMD Calculator (Note that it uses a life expectancy factor which looks different, but works out to be the same as the percentages we just mentioned). Many financial advisors believe that this changing percentage makes a good way to take money out of your other retirement accounts. Since the withdrawal formula starts low and gets higher over time, it offers more safety than plans that take out steady amounts over time – the smaller distributions in early years make it less likely that you will run out of money in the long term.
Comments? Have you had any problems calculating your required distributions, or other issues? Please share your thoughts in the Comments section below.
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.