Many retirement accounts, like traditional IRAs and employer-sponsored 401k plans allow you to postpone paying taxes on pre-tax contributions you made to the account, plus earnings, until you start taking distributions. That’s why they’re called tax-deferred retirement accounts, and they’re a great way to help you save for retirement. But the IRS will eventually get those deferred tax dollars from you - thanks to a rule called Required Minimum Distributions, or “RMDs”.
Be ready when your RMDs kick in
The whole point of tax-deferred retirement accounts is to accumulate more money for retirement by not paying current taxes on contributions you make to the account, plus earnings. But when you take money out of these accounts, the amount you receive will be subject to federal income tax. Tax laws require you to begin taking minimum, annual withdrawals from your tax-deferred retirement accounts. If you own an IRA, the first minimum withdrawal needs to be made on or before April 1 following the year in which you turn 70½. If you are a participant in a plan, the first RMD must generally be made no later than April 1 following the year in which you turn 70½ or the year in which you retire. You can withdraw as much as you want, but you must withdraw a required minimum amount, whether you need the money or not - hence “Required Minimum Distributions”.
You can start taking withdrawals earlier too, but if you take a withdrawal prior to turning 59½ a 10% premature distribution penalty tax may apply. If you don’t need to take withdrawals, you can leave your money in the accounts for continued growth potential.
Do the math
If you are a participant in a 401k plan, you will need to calculate your RMD using your account balance as of December 31 of the prior year and must generally begin taking RMDs by April 1 following the later of the year in which you turn age 70½ or the year in which you retire. Say for example:
- You have $373,000 in your 401k on December 31, 2016 and you turn 73 in 2017.
- Based on the Uniform Lifetime Table, IRS Publication 590, your life expectancy factor would be 24.7.
- $373,000 ÷ 24.7 = $15,101.
- The 2017 RMD for your 401k account would be $15,102.
After the first RMD distribution year, you will need to take an RMD by December 31 of each year. If you have more than one defined contribution plan, you may need to calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan. If you have more than one 403b tax-sheltered annuity account from the same sponsor, you may choose to total the RMDs and then take them from any one (or more) of the tax-sheltered annuities.
Similarly, each year take your December 31 balance in your IRA account and divide by a life expectancy factor based on your age, according to the Uniform Lifetime Table. The result is your RMD in dollars. You’ll need to take this RMD amount out by December 31 of each year, except the first year after turning 70½, where you have an extension to April 1 of the following calendar year. However, you may aggregate your RMD amounts for all of your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA.
If you own an IRA and also participate in an employer-sponsored plan like a 401k plan, you will need to perform two separate calculations and take out the RMD from each account on an annual basis.
Tips for RMD planning:
- Make a plan — Your RMD is the minimum you must take out. Create a withdrawal strategy to make sure you are taking out enough to meet your needs, but not so much that you’ll deplete your accounts too soon. Some retirement accounts offer distribution options that satisfy the RMD rules so that you don’t have to do the math. If you don’t take the RMD by the deadline, you may be subject to a 50% excise tax on the amount that should have been withdrawn.
- Consolidate multiple accounts — Since you need to calculate your RMD every year, consider consolidating your retirement accounts to simplify the process.
- If you are still working at age 70½ – your plan may permit rolling over your IRA accounts to the employer plan where you are actively working prior to age 70. Then you will not need to take your RMD until you separate from service.
- Reinvest unneeded RMDs — If you don’t need the income to help cover your retirement expenses from your RMD, you could reinvest the distribution in one of your taxable accounts to cover future unanticipated expenses (medical) or invest it for your grandkids future education.
- If you don’t want to deal with RMD’s - Roth IRAs do not have RMD requirements for the original owner or your spouse. However, RMDs will apply after the owner’s death for beneficiaries who are not your spouse. Please also note that there may be tax consequences associated with the conversion of an IRA to a ROTH IRA.
Work with a pro
With the over 200 pages of rules written in the Department of Treasury specifically for RMDs, the nuances can be easily tricky. If you fail to take one or miscalculate and take too little, you’ll owe a penalty of 50% on top of the federal income taxes you will pay on the withdrawal. The rules for beneficiaries are even more complex. It is recommended that you speak with your own legal counsel to understand the federal income tax consequences based upon your individual facts and circumstances. Voya cannot provide you with legal and/or tax advice.
Carefully consider the provisions of your current retirement plan and the new product for differences in cost, benefits, surrender charges or other important features before transferring assets. A Voya Financial Advisors financial professional can help you review and compare all your options to help you determine what makes the most sense for you.
This material is provided for general and educational purposes only; it is not intended to provide legal, tax or investment advice. All investments are subject to risk. We recommend that you consult an independent legal or financial advisor for specific advice about your individual situation.
The information herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties. Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor.
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Neither Voya nor its affiliated companies provide tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.