Retirement requirement: Distributions
Joel Dresang: Dave, a lot of people save for retirement through tax-deferred accounts like IRAs and 401(k)s, which allows them to benefit from not having to pay taxes on the money they put into the account, but they have to take the money out of the account, and that’s when it’s taxed. And I want to talk to you today about those distributions, the required minimum distributions.
Dave Sandstrom: Yes, Joel. The required minimum distributions – or RMDs, as they’re commonly referred to – are the government’s way of having us start an income stream from those accounts in retirement.
So the government has given us the benefit to let that money accumulate, earn interest, grow throughout our working careers, but at some point in time it’s intended to be spent in retirement. And 70½ is the year in which they require those distributions to start.
Specifically, your first distribution is due to be out by April 1st of the year following the year you turn 70½. And then after that, subsequent years, it just has to be out by the end of each calendar year.
Keep in mind that those distributions, every dollar that comes out, will be treated as taxable income.
Joel: Or what? What happens if you don’t take that requirement minimum distribution?
Dave: Penalties are stiff, Joel. The IRS will impose a 50% penalty on any amount that isn’t taken out. So if you if you had to take out $1,000, and you didn’t, in addition to the taxes that you’re going to have to pay on that, the IRS is going to ask you for another $500.
Joel: Required minimum distribution. How do I know what the minimum is?
Dave: So Joel, it’s a combination of things that the IRS looks at to determine the amount that has to come out each year. Number one is going to be basic life expectancy calculation. And then of course, the other one is the balance that is in those retirement accounts.
In effect what you’re doing is you’re taking the amount of years that you have estimated to live and you divide that into the balance of your IRA or your 401(k) and that amount will then be your RMD for that year.
Joel: And there are calculators that figure that out from the IRS.
Dave: That’s correct. Widely available, Joel. But remember, the burden is on the taxpayer to make sure they know that their RMD is due that year and how much that RMD is.
Joel: So that first RMD sounds complicated: 70½. So I’m, an April 4th birthday. I turn 70 and a half on October 4th, that means I need to take my first RMD by the following April 1st, and then the next RMD has to be in that same calendar year.
Dave: Yes, potentially, Joel. You can take it out, though, in that year you turn 70½. And that’s most common for people to do because people like to spread out that income. Otherwise, you’re taking two distributions in the same tax year.
But I would recommend that you consult a tax professional on that because there are instances where you may benefit from doubling up in that second year versus taking it across two years.
Joel: What about subsequent RMDs? Are there certain strategies to take for those?
Dave: You know, I think it’s going to be different for everyone, Joel. It’s very important to look at the big picture and plan ahead.
It’s very different for every individual. So think about it, if you’re using the RMD for let’s say your living expenses, people like to set up possibly a monthly distribution throughout the year that equals the RMD.
Other people who maybe don’t need the money for living expenses might wait until the end of the year in the hopes that they’ll maximize the growth of the money.
Some people who don’t need it at all, will take it out and just transfer that money into a non-qualified taxable investment account to keep it growing. Keep in mind that you’re still responsible for the taxes in that situation.
And then there’s also something known as a qualified charitable distribution where you can designate your RMD for the year to a charity, and if it goes directly to that charity, the government won’t collect any taxes.
Joel: Now, I’m not turning 70½ this year. Why should I know about RMDs ahead of time?
Dave: Well, Joel, it’s just like anything. I think it’s really important to plan ahead.
Some people are in a unique situation where potentially their income will go up in retirement, and they might pay more in taxes. So there might be a strategy in which you take some distributions early – before 70½ – to lower the amount so that you’re taking smaller distributions in retirement.
I would recommend talking with a tax professional well in advance so that you can devise a plan which is going to help you minimize the amount of taxes that you pay.
Joel: So you talk about seeing tax professionals. This can get kind of complicated.
We’ve got some links to more information (Please see below.). You can go to the IRS.gov/RMD for more information. But is it so complicated that I shouldn’t think about putting money into an IRA or a 401(k)?
Dave: Joel, I wouldn’t want to have anybody be deterred from using this. It’s a very effective retirement planning tool, tremendous advantage to let that money grow over long periods of time tax-deferred. So please don’t take it as a fear or a concern.
But there are some pitfalls along the way if you don’t do it correctly. So, as with anything in investing, it’s a pretty good idea to enlist the help of a professional and to always plan ahead.
When should I …take my required minimum distribution? by Chris Evers
The ABCs of RMDs, by Clare McNamara
FAQs about RMDs, from the IRS
Selecting Retirement Payout Methods, from the Financial Industry Regulatory Authority
Distributions from Individual Retirement Arrangements (IRAs), from the IRS
Dave Sandstrom is vice president and an advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik
(initially posted June 29, 2017)
Send us a question for our next podcast.
More information and insight from Money Talk
Money Talk Videos
Follow us on Twitter.
Landaas newsletter subscribers return to the newsletter via e-mail.