Steve James is a patient man -- at least when it comes to his IRA.
James, a 66-year-old retiree living in Vermont, doesn't plan on withdrawing money from his individual retirement account any time soon. For now, he doesn't need the money.
"Long ago we paid off our mortgage and we have no major debt, so Social Security and my wife's part-time earnings keep us afloat," James explained. He's content, he said, to let his money grow in his IRA, untouched.
But there will come a time soon when James will have to start withdrawing funds, whether he wants to or not, or else pay a price.
That's because IRS rules for tax-deferred retirement accounts such as traditional IRAs, traditional 401(k)s and Roth 401(k)s mandate that retirees start taking required minimum distributions (RMDs) when they reach age 70½. The rules do not apply to Roth IRAs.
If you're planning on waiting until you hit 70 to begin withdrawing from your tax-deferred accounts -- or have only been withdrawing small amounts, here are a few important things to keep in mind.
No fooling! April 1 is an important day for first-time RMD takers
Per IRS rules, savers must take their first RMDs by April 1 of the year following the calendar year in which they reached age 70½. After that, all subsequent annual RMDs must be taken by Dec. 31. This can get tricky, so here's a quick example.
Say your 70th birthday is July 15, 2016. You turn 70½ on Jan. 15, 2017, so that means you have to take your first RMD (which would count for 2017) by April 1, 2018. You would have to take your second RMD (for the 2018 tax year) by Dec. 31, 2018. If you wait until the deadline to take your first RMD that means you'll have to take two RMDs in one calendar year to avoid penalties.
Calculating RMD is a matter of life and death...kind of
To determine your RMD for a given year, you need to divide the balance of your account on Dec. 31 of the prior year by a life expectancy factor included in tables published by the IRS.
Your RMD will often be considered taxable income
You likely learned this when you first opened your retirement account, but here's a reminder: For traditional IRAs and 401(k)s, while you didn't pay taxes on the money contributed to those accounts, you will be subject to taxes on the money withdrawn from those accounts. Qualified distributions from Roth 401(k)s are not taxed, but the IRS says to check with your plan administrator regarding any possible RMDs
Failing to take your full annual RMD will cost you
Individuals who don't take the full amount of their required minimum distributions are subject to a 50% excise tax on the amount not distributed.
It's possible to fix RMD mistakes
If you make a mistake on your RMD that leaves you open to the excise tax, you may qualify for a waiver if you can show the IRS that you made a "reasonable error" and are taking "reasonable steps...to remedy the shortfall." To apply, seniors must file a Form 5329 and include a letter of explanation.
This article originally appeared on thealertinvestor.com.