If you're retired, you likely know about required minimum distributions (RMDs), the minimum amounts you must withdraw from your retirement accounts each year. Generally, distributions are required when you reach age 73 (or 75 if you were born in 1960 or later).
At first, RMDs may seem confusing, and it's easy to see how errors can occur. The trick is knowing what to look out for. Here are five of the most common RMD mistakes.
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1. Missing the deadline
If this is your first RMD, your deadline is April 1 of the year after you turn 73 (or 75). After that, you have an annual Dec. 31 deadline.
Retirement can be a busy time of life. You're probably spending more time doing the things you want. You may be turning a hobby into a small business, or relocating to another part of the U.S. The point is, you probably have a lot going on.
Having plenty to do is great, but it can also make it more challenging to keep your calendar straight. If you happen to miss a deadline, the IRS imposes a 25% penalty on the amount not withdrawn. For example, if you were supposed to withdraw $10,000 and it slips your mind, you're looking at a $2,500 penalty. However, if you correct the mistake within two years, the IRS may lower the penalty to 10%.
2. Assuming RMDs don't apply to you because you're still working
According to Pew, employment is the third most common source of income for older adults (after Social Security and retirement accounts). But even if you're working when RMDs come due, you can't assume you don't have to take them. If you have an employer-sponsored retirement plan from an old job -- like a 401(k) or 403(b) -- you must follow regular RMD rules for withdrawal.
The only exception is if you're contributing to a retirement plan through your current employer. If that's the case, you can likely delay RMDs until you retire, provided you don't own more than 5% of the business.
Note: The "still working" exception does not apply to IRAs. You're required to take RMDs from all traditional IRAs once you reach 73 or 75 (depending on the year you were born).
3. Miscalculating an RMD
Part of your retirement income strategy probably involves the funds you withdraw through RMDs. However, it's easy to get confused about which IRS life expectancy table to use, which can lead to insufficient withdrawals and penalties. Here's how calculating RMDs generally works:
- Use your account balance as of Dec. 31 of the previous year.
- Locate your life expectancy factor on the IRS table, based on your age when you're taking the RMD.
- Divide your account balance by your life expectancy factor to find your RMD.
If you're nervous about making the calculations or want to check your work, this AARP RMD calculator can be helpful.
4. Combining RMDs from different accounts
Let's say you have three IRAs. IRS rules dictate that you must calculate the RMD for each IRA separately. However, you can aggregate (combine) RMD amounts for your IRAs and withdraw the total from one. Or you can withdraw a portion of the total RMD from each account.
However, the same rule does not apply to all retirement accounts. For example, RMDs for defined contribution plans, such as a 401(k), must be calculated and withdrawn separately. So, if you and your spouse each have a 401(k), or you have separate defined contribution plans from past employers, you can't combine the totals and take the RMD from a single account.
5. Believing excess withdrawals one year count toward the next
Imagine you plan a European vacation and withdraw more than your required RMD to cover the cost. While you're free to withdraw more than required, you cannot apply withdrawals in excess of your required distribution to future years' RMDs.
Whether you have an IRA, 401(k), or other retirement plan, you worked hard to build the account. Don't lose any of that money to penalties caused by silly mistakes.
