If you are over age 72, or have an inherited IRA, you may be required to withdrawal some of your IRA or Solo 401(k) account each year. This concept is referred to as Required Minimum Distributions (RMDs).
Failing to take your required minimum distribution as required will result in a hefty tax penalty. Planning ahead and understanding best practices for managing your RMDs can help you avoid headaches as well as hefty fines.
Know What Accounts are Subject to RMD’s. Following are the retirement plan accounts subject to RMDs:
- Any tax-deferred IRA (Traditional, Rollover, SEP, SIMPLE) in your name if you are age 72 or older.
- Any 401(k) or similar employer plan, tax-deferred or Roth, if you are age 72 or older. There is an exception if you still work for the employer and have less than 5% ownership in the employer.
- A non-spousal inherited IRA of any tax type, if the original account holder passed on or before December 31, 2019.
- A non-spousal inherited IRA of any tax type, if the original account holder passed on or after January 1st, 2020, and you are a minor, disabled or chronically ill, or not more than 10 years younger than the original account holder.
Confirming your minimum withdrawal. Many financial institutions will calculate your RMD for you, which can make the process easier. However, you’ll be the one who ultimately pays for any errors. It’s wise to know how to calculate your RMD and to double-check the amount yourself each time. Calculate a separate RMD for each of your accounts by dividing the account’s value as of Dec. 31 of the previous year by your life expectancy according to the IRS.
Automating your RMDs. The penalty for missing the annual deadline is harsh—a full 50 percent of the amount you should have withdrawn. Setting up automatic RMDs through your financial provider takes the hassle out of the process and keeps your distributions on schedule. If you prefer not to go that route, consider setting up an annual calendar reminder that gives you plenty of time to calculate your RMDs and request the necessary paperwork before the deadline.
Consolidating your accounts. If you have multiple retirement accounts with different financial institutions, the withdrawal process can quickly become cumbersome. You can simplify matters by bringing all of your accounts under one roof. It might also help to roll any 401(k)s still held by former employers into an IRA.
Withdrawing strategically. If you have more than one retirement account, you don’t have to take the individual amount from each account separately. Instead, you can take your total RMD from whichever qualified source (or combination of sources) is most advantageous to you. For example, if you have two IRAs with a total RMD of $5,000, you can take your withdrawal from one account or spread it between the two however you choose.
Planning for the long term. If you hold illiquid assets, you’ll need to consider well in advance how you’re going to maintain enough cash flow to take your required minimum distribution each year.
Reinvesting your RMDs. If you don’t need to live on the withdrawals, you can choose to reinvest them in a taxable account instead. That way, your retirement savings can continue to grow.
Consulting a tax advisor. Required minimum distributions count as taxable income, so you’ll need to be prepared to handle the tax implications. Speak with your licensed tax advisor.
With proper management, your required minimum distributions don’t have to be a drain on your time, energy or retirement fund. As long as you comply with the rules, you’ve got a plenty of room to make the best possible decisions for your retirement savings.
This page has been updated to reflect law changes implemented with the SECURE Act of 2019.