Over 70? You Have Until Dec. 31 to Avoid a 50% IRS Penalty

You definitely don’t want to get this retirement savings move wrong.

Matthew Frankel, CFP
Matthew Frankel, CFP
Dec 13, 2018 at 6:47AM
Investment Planning

The term RMD, or required minimum distribution, refers to the amount of money that certain people must take out of their retirement accounts each year. The idea is that investors can use tax-deferred investment accounts, such as a traditional IRA, to allow their investments to grow and compound without having to pay any capital gains or dividend taxes, but they can't simply let their money grow forever. At some point, the IRS wants to get paid.

With that in mind, here's how to determine if you need to take an RMD in 2018, and if so, how much. You don't want to get this wrong -- there's a stiff penalty for not withdrawing enough.

Older man withdrawing money from an ATM.

Image source: Getty Images.

When do you need to start taking RMDs?

The RMD rule kicks in at age 70 1/2. After this point, owners of tax-deferred retirement accounts are required to withdraw a certain minimal amount of money each year. The required withdrawal amount is based on the account's balance and the owner's remaining life expectancy, and we'll look at an example of how it works in a bit.

Just to name a few examples, some of the accounts subject to RMD requirements are traditional IRAs, 401(k)s, 403(b)s, SEP-IRAs, and SIMPLE IRAs. Roth IRAs are not subject to the RMD rule, as these are after-tax accounts, so the IRS cannot tax qualified withdrawals and doesn't really care how long you leave your money in the account. However, it's important to mention that Roth 401(k) accounts are subject to RMDs.

There's one key exception to the RMD requirement for employer-sponsored retirement plans, such as 401(k)s. If you're still working for the sponsoring employer, you can delay taking RMDs until after you retire, regardless of your age. However, even if you're still working, you'll need to take RMDs from your IRAs and any other retirement plans that are subject to the RMD rules.

When do you have to take yours?

Generally, you'll need to take your RMD by Dec. 31 in every calendar year after you turn 70 1/2. So if you turned 75 in 2018, you'll need to calculate the appropriate RMD for you and withdraw the money from your retirement accounts before New Year's Day.

The exception is your first RMD. Your very first RMD doesn't need to be taken until April 1 in the year after the year in which you turn 70 1/2. So, if you reached age 70 1/2 in October 2018, for example, you technically don't need to take your first RMD until April 1, 2019.

However, there's a big caveat to keep in mind. If you wait until the last minute to take your first RMD, you'll end up taking two RMDs during the same calendar year (your first one plus the next one you're required to take by Dec. 31). And remember that withdrawals from tax-deferred accounts are considered taxable income. The point is that this can result in an unexpectedly high income in a single year, which could easily propel you into a higher tax bracket and increase your tax bill more than you're expecting.

How to calculate your 2018 RMD

There are two RMD life expectancy tables provided by the IRS. Most people will use the uniform lifetime table, which you can find on an IRS worksheet. If your spouse is more than 10 years younger than you and is the sole beneficiary of your retirement account, you'll use the Joint Life and Last Survivor Expectancy table to find your expected distribution period. You'll also need to know your account's balance at the end of the previous year.

Here's an example of how this works. Let's say that you have an IRA and that you turned 74 in 2018, and that your account's balance was $250,000 as of Dec. 31, 2017. For simplicity, we'll say that you qualify to use the uniform lifetime table, like most retirees.

To calculate your RMD, you would divide your balance at the end of last year ($250,000) by your expected distribution period, which the uniform distribution table lists as 23.8 years for a 74-year-old. This calculation results in a 2018 RMD of $10,504.20.

It's also worth mentioning that if you have several retirement accounts that are subject to the RMD requirement, you don't necessarily need to withdraw money from every account. You can calculate your RMD using your total account balance and withdraw the required amount from whichever account, or combination of accounts, you choose. As a simplified example, if you have three IRA accounts, each with an RMD of $10,000 for 2018, you can simply take $30,000 from one account.

You can also choose to take your RMD in a lump sum, or as a series of payments throughout the year, as long as you've distributed at least the required minimum by Dec. 31 each year.

The penalty for not taking your RMD is harsh

Whatever you do, don't ignore the RMD rule. If you are required to take a distribution from your retirement savings and fail to do so, the IRS assesses a penalty equal to 50% of the amount you should have withdrawn but didn't. This is one of the harshest penalties the IRS imposes on Americans, so it's certainly worth taking the RMD rule seriously.