Jim, a very sophisticated client recently called me because he was worried about the IRS. He will turn 70 next January and just wants to make sure he complies the rules on mandatory distributions from retirement accounts. He’s confused and he’s not alone. It can be easy to get mixed up on this topic. Not because it’s complicated. Because it’s just not explained very well. Let’s go through Jim’s situation to clarify.
When Do You Start Taking Your RMDs?
The IRS wants you to start taking money out of your IRA the year after you reach age 70 ½. But for simplification sake, most people start taking the money the year they turn 70 ½.
For Jim, that means he’ll have to get his ducks in a row next year because he will turn 70 next January and 70 ½ in July. Had he been born in July or later, he could delay taking his RMDs until the following year. Why? Well….if you were born in October (for example) you won’t have a half birthday until April of the following year. So if Jim had been born in October rather than January he wouldn’t have to start his RMDs next year but the year after. I told you this was easy.
How Much Should You Take Out?
This is even easier than figuring out when to start your payments. To calculate the RMD, get the account value as of December 31st of the preceding year. Let’s say it’s now 2016. Since Jim is going to turn 70 ½ in 2017, he would look at the 12/31/16 value of his IRA in order to calculate the RMD he must take in 2017. Obviously he won’t be able to make that calculation until 12/31 passes. No problem.
Once Jim has the 12/31 value, he goes to the IRS tables and gets his “factor”. The IRS table provides this “factor” based on your age. For example, if you are 70, your “factor” is 27.4. If you are going to turn 71 during the year you start your RMDs, you use 26.5
Jim takes the account value and divides it by his factor. So, if Jim’s 12-31 balance was $100,000, he would take that number, divide it by 27.4 and withdraw $3650 and satisfy the IRS’s RMD.
When Is The RMD Taxable?
The money you withdraw is taxable the year you receive the money. If Jim receives his RMD next year, that’s the year he reports it on his 1040.
What if you have more than one IRA?
The IRS doesn’t care which account you take the RMD out of – but they want you to calculate your total RMD based on all your IRA accounts. In other words, if Jim had 3 IRAs totaling $100,000 rather than having all the money in one account, he would still have to take the same $3650 out of this total. The government does not care which account you take the money out of but they do insist that you take the RMD based on the total amount you have in IRAs.
What if you don’t take your RMD out on time?
I was afraid you’d ask that. If you fail to take your RMD out the penalty is 50%. So, if Jim’s RMD is $3650 and he only took $2650 – he would have a penalty of $500. That’s because he took out $1000 too little and 50% of $1000 is $500.
What If You Don’t Need The Money
The IRS doesn’t care. They want you to take your RMD regardless.
Do I Need To Take RMDs From Every Retirement Account?
IRAs, profit-sharing-plans, SEP, SARSEP, SIMPLE IRA, 403(B) 457’s, 401(K) (unless you are still working where the plan is being sponsored) are all subject to RMDs. Roth IRAs do not have an RMD requirement but Roth 401(K) plans are.
Why You Really Don’t Need To Worry About RMDs
In almost all cases, your custodian is going to calculate your RMD amount and contact you. All you have to do is collect those nice checks and figure out a way to enjoy the money. If you want to play it safe, make a list of all your retirement accounts subject to RMD and make sure each custodian contacts you in the early part of the year. If they don’t, reach out to them to get clarification.
If you want to make your life simpler, consider consolidating your IRAs into one or two custodians. When you have multiple IRAs it is a little harder to keep track of and there’s really no benefit of having more than one account. But bottom line? RMDs are nothing to be intimidated by.
Do you have any other RMD questions? What are they?
If you wait to take your first RMD until the year *after* the year you turn 70 and a half, you’ll have to take *TWO* RMDs that year. According to IRS publication 590a, chapter 1 page 7, “You must start receiving distributions by April 1 of the year following the year in which you reach age 70 and a half. See Pub. 590-B for more information about Required Minimum Distributions (RMDs) and other distribution rules.” But what they don’t tell you is that that is a “grace” period for the year you actually turn 70 and a half. You will also need to take out that subsequent year’s RMD in addition. So that makes *TWO* RMD withdrawals from your accounts for the same year. For some people, depending up their tax situation (maybe you are still working, or you come into some other taxable income) it way be advantageous to delay that first year’s RMD withdrawal to the next year, but for most people it would be wise to take that first RMD in the year that you actually turn 70 and a half and not have to pay taxes on two years withdrawals in the same year. Just an FYI…
Neal Frankle, CFP ® says
Thanks. Completely true.