If you're going to save for retirement (which you should, since you'll need income to supplement Social Security), you might as well snag some tax breaks along the way. That's why retirement plans like traditional IRAs and 401(k)s are so popular.
With a traditional IRA or 401(k), you get to fund your savings on a pre-tax basis, allowing you to pay the IRS less tax each year you make contributions. Plus, investment gains in these accounts are tax-deferred, so you don't have to pay the IRS year after year. Rather, you only pay taxes when the time comes to take withdrawals.
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But speaking of withdrawals, one thing traditional IRAs and 401(k)s do not allow you to do is decide when to remove money from your savings. Once you reach a certain age (either 73 or 75, depending on your year of birth), withdrawals become mandatory.
They're known as required minimum distributions, or RMDs, and the only way to get out of them is to house your retirement savings in a Roth retirement plan. But if it's too late for that, make sure to keep RMDs on your radar, because failing to take them could be costly.
A missed RMD could deal your finances a huge blow
The amount of money you need to withdraw in RMD form changes from year to year. And it's calculated based on your retirement plan balance and life expectancy.
If you don't take your RMD on time, you'll generally face a 25% penalty on the sum you fail to remove. A $10,000 RMD, for example, could cost you $2,500 if you neglect to take it.
Vanguard reports that in 2024, almost 7% of its IRA holders missed an RMD. And the average RMD amount savers were supposed to take was $11,600.
If we do the math, a 25% penalty on that sum amounts to $2,900. That's a lot of money to give up for no good reason. And if you're on the hook for larger RMDs, you could be looking at even higher penalties for missing them. So it's important to avoid that situation.
Know when RMDs are due and arrange for them in advance
You're allowed to defer your first RMD to April 1 of the year after you turn 73. But generally speaking, RMDs are due by Dec. 31 each year.
That's a pretty easy date to remember. But if you want to avoid a missed RMD penalty due to forgetfulness, put those withdrawals on autopilot.
Most financial institutions allow you to set up automatic RMDs. You can generally choose to receive your money monthly, quarterly, or annually. Automating your RMDs could be your ticket to avoiding a costly penalty, so it's worth seeing if that option exists.
Meanwhile, if you've already missed an RMD, aim to correct that mistake at once. The IRS will usually drop your 25% penalty down to 10% if you take your RMD within two years of the missed deadline.
But even a 10% penalty could constitute a big loss if your RMD is on the larger side. So it's best to automate the process so you don't risk any penalties at all.
