If you're making good use of tax-advantaged retirement accounts such as IRAs and 401(k)s, good for you! They can be powerful helpers as you save and invest for retirement. You need to be aware, though, that once you reach a certain age, some of those accounts will make you take Required Minimum Distributions (RMDs).
Here's a look at what RMDs are, along with several critical things to understand about them. If you mess up with RMDs, the penalties can be quite costly.
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Meet the Required Minimum Distribution
Our friend -- the Internal Revenue Service (IRS) -- requires people to take annual RMDs from accounts such as traditional IRAs, SEP IRAs, and SIMPLE IRAs once they reach the age of 73. When you do so, that income will count as taxable income to you -- so it's smart to account for it when you're devising your retirement plan. Failing to have a retirement plan is a big mistake. Here are seven others, all related to RMDs.
1. Missing the RMD deadline
First, don't be late! You have until April 1 of the year after you turn 73 to take your first RMD. After that, though, the deadlines fall on Dec. 31. So your second RMD will be due on Dec. 31 of the year you turn 74.
You might want to take your first RMD in the year you turn 73. Otherwise you face having to take both your first and second RMD in the same year, the year you turn 74. That can boost your taxable income a lot for that year.
2. Withdrawing the wrong amount -- or not withdrawing at all
When taking your RMD, you'll want to withdraw the correct amount -- at least. You can calculate your RMD by referring to an RMD table, but many good brokerages will calculate your RMDs for you and will often let you set up automatic withdrawals. That can help you avoid missing the deadline, though it's also smart to check now and then to ensure that your brokerage has indeed scheduled your RMD.
If you fail to take your full RMD on time, you'll likely pay a steep price. The penalty for not taking them on time is 25% of the amount you failed to withdraw on time. Fail to take out $6,000, and you may face a $1,500 penalty! (You may be able to pay a smaller penalty if you notice that you just missed the deadline and take action quickly.)
3. Not understanding how RMDs from IRAs and 401(k)s work
Here are some things to know about RMDs from various types of accounts:
- With Roth IRAs and Roth 401(k)s, you do not need to take RMDs.
- With traditional IRAs and with 403(b) accounts, if you have more than one account, once you total your RMDs from all of your accounts, you can withdraw that total sum from just one or from multiple accounts. So if your RMD for the year is $6,000, you could take all $6,000 from just one of your IRAs, or $2,000 from one and $4,000 from another, or some other combination.
- With traditional 401(k)s, you must take the RMD required from each one, and you can't mix and match as you can with IRAs.
- If you're still working, you may not have to take your RMD from your workplace's retirement account until you retire.
4. Thinking your spouse's RMD counts as your own
If you're married and both you and your spouse have RMDs to take each year, you can't withdraw from one of your accounts to satisfy the requirement for the other spouse. So, for example, if your RMD is $6,000 and your spouse's is $4,000, you can't take $10,000 from your account and consider theirs satisfied. Each of you will need to withdraw your own RMDs from your own account(s).
5. Donating to charity without considering a qualified charitable distribution (QCD)
If you donate to charity, you may be able to avoid being taxed on some or all of your RMD if you execute a "qualified charitable distribution" (QCD). Doing so means you would have funds sent directly from your retirement account to a qualifying charity. You cannot just withdraw the money and donate it and then expect to pay no taxes on the withdrawal -- the sum needs to go directly to the charity. There are some other rules, too, so read up on this if it's of interest to you.
6. Spending your RMD when you don't need to do so
Some people mistakenly think they have to take their RMD and spend it. That's not the case. You can always reinvest that money right away, parking it in shares of stock, certificates of deposit (CDs), or wherever you want.
7. Not keeping up with RMD changes
Finally, be sure to keep up with RMD rules, because they can change sometimes. For example, according to some new rules, some beneficiaries must take RMDs from inherited IRAs, depleting them within 10 years. This rule doesn't apply to spousal heirs, but does apply to most heirs who were not married to the IRA owner who died -- if that IRA owner had reached age 73 before dying.
The more you know about retirement accounts, RMDs, and tax matters, the more you may be able to save.
