At this time of year, most taxpayers are squarely focused on the annual mid-April deadline to get their tax returns done and filed with the IRS. That causes many people to ignore the fact that there's another earlier deadline at the beginning of the month that applies to a very specific set of taxpayers. No fooling: If you miss that April 1 date, you could owe one of the most draconian penalties in the tax laws.
In general, those who are 70 1/2 or older have to start taking required minimum distributions (RMDs) out of their traditional IRAs, 401(k)s, and other retirement accounts. For the roughly 3.3 million Americans who turned 70 1/2 during 2017, a special extension gives them until April 1 of the following year to take out a certain amount from their eligible retirement accounts. To make sure people take that requirement seriously, you'll have to pay 50% of what you should have withdrawn if you miss the deadline. With just days left before April 1, you can't afford to wait any longer to take action.
The basics of RMDs
The rationale for having required minimum distribution rules stems from the tax benefits that IRAs, 401(k)s, and other plans offer. Tax deferral lets you keep money that would otherwise go to Uncle Sam, and lawmakers didn't want that state of affairs to last forever.
The RMD rules therefore make you start taking out certain amounts starting when you reach age 70 1/2. So if you were born between July 1, 1946, and June 30, 1947, then you'll have to take out that appropriate amount by April 1. Thereafter, the deadline becomes Dec. 31, so you'll have even less time to avoid the penalty in future years.
How much money do I have to take out of my retirement accounts?
To help you come up with the right RMD, the IRS provides a worksheet (opens a PDF) you can use to make the necessary calculations. You'll need to come up with your life expectancy as defined on the IRS uniform life table that's part of the worksheet, and you'll also need to know how much money you had in your retirement accounts as of the end of 2016.
After you've come up with both of those numbers, the math is simple: Just take the total amount you had in eligible retirement accounts and divide it by the life expectancy number. That will tell you how much your required minimum distribution has to be to avoid the 50% penalty.
Early in retirement, your required minimum distributions are relatively small. For instance, according to the table, from ages 70 to 72, you have to withdraw less than 4% of your total balance. By age 79, that's up to 5%, and it takes until age 93 before your RMD tops the 10% level. The net result is that most retirees end up taking similar-sized chunks of money out on a regular basis.
2 things to know
There are some special rules that you should know about before finalizing your retirement account withdrawals. First, there's no penalty for taking more than your required minimum distribution. At 70 1/2 or older, you're well above the 59 1/2 minimum age to take penalty-free withdrawals. So if you need more money than your RMD calculation would show, that's not a problem.
Also, not all retirement accounts are subject to RMD rules. Roth IRAs have no requirement for minimum distributions. Some retirees start taking greater advantage of Roth IRAs by converting traditional IRA and 401(k) assets to Roths earlier in retirement, setting up a nest egg over which they have complete control with respect to timing of withdrawals. Such conversions are almost always available, although they come at the price of paying current income tax on the amount of money converted to the Roth.
With April 1 falling on a Sunday, you only have a few days left to contact your financial institution and get the RMD paperwork moving. With such a huge penalty, though, there's plenty of motivation to sneak in under the wire before you risk losing half your distribution to the IRS.