Required Minimum Distribution Rules For IRA and 401k’s

required minimum distribution rulesRemember the first day you put money into your retirement account?

You have seen your retirement account grow over the years and you have been blessed because you have never had to tap into it.

Now the grand-kids are your new focus and you have decided to just pass it on them since you will never need it.

You have just turned 70 and a friend of yours in a similar situation is griping because they had to pay taxes on their retirement plan because they had to take money out.

Puzzled on the IRS rules you do some research (or go to my blog) and you learn about Required Minimum Distributions.

We’ll call them RMD’s for short.

It’s Time To Take Your Distributions

The beauty of investing in retirement plans is the tax deferred growth. All these years you’ve seen your account grow but never had a 1099 you had to report any of those gains on. You planned well enough were you have prolonged withdrawing even longer now, but you can only hold out for so long. The IRS is chomping at the bit waiting to get some of that tax money back. They do so with RMD’s by making you take out a portion of your retirement account each year and pay the respective tax on it.

If you don’t take it out, you get taxed 50% of the amount that you should have taken.

That’s a pretty stiff penalty that you want to avoid.

RMD’s and 401k’s

Typically, the same required minimum distribution rules apply to your 401k as your IRA.   The big difference, however, is if you are still working until after you’ve reached 70.5.  In that case, the IRS allows you to postpone your RMD’s up until the day you retire.  That’s a good scenario for those that haven’t saved enough and continue to work to boost their retirement savings.

When do RMD’s  have to start?

The IRS says you must start by April 1 following the year that you turn 70 and a half, and you must do it each year ongoing. Some retirement plans will allow you to postpone withdrawing so long as you are still employed by that company. Keep in mind that April 1 is for the first year and the first year only. After the first year, it falls back to a calendar year schedule and must be withdrawn by December 31.

RMD Example

Somebody born on July 1, 1940 would not turn 70.5 until January 1, 2011. That means that they would not have to take their first RMD until April 1, 2012 (which would satisfy 2011 RMD requirement). They would, however, be required to take another distribution that year by December 31, 2012 to satisfy for that year. Each year following would follow the December 31st deadline.

How much do you have to take?

The amount will also be based on the previous year’s balance in your retirement plan. For example, to figure your RMD for 2011 you would take the value of your plan as of December 31, 2010.

The amounts to be withdrawn are based of life expectancy tables issued by the IRS which factor in your age, your beneficiary’s age, and your relationship with your beneficiary. Based on the 2011 Uniform Life Expectancy Table, you can expect to be required to withdraw 3.65% of your retirement plan when you turn 70.5. It then increases to 3.77% the next year and increases each year ongoing. The IRS tables are named:

  • Single Life Expectancy
  • Joint Life and Last Survivor Expectancy
  • Uniform Lifetime

The tables are helpful, but nowadays calculators are used to compute the amount with ease. Please seek guidance from a financial professional to ensure that you are taking your RMD’s correctly.

Do You Have to Calculate RMD’s on Your Own?

Luckily, no.  Most financial institutions will calculate the figure for you.   For all my clients that have reached RMD age, my custodian calculates the RMD amount for my clients and then I contact the client to notify them of the amount.

Another thing to consider is that since it is a taxable distribution, your IRA custodian will most likely require you to sign a form to take out the money (at least the first time).  If a form needs to be signed, don’t procrastinate and wait till the last minute.

What About RMD’s and Roth IRA Conversions?

With the rules regarding Roth IRA conversions now lifted, I’ve had several RMD candidates inquire about converting their RMD’s directly into a Roth IRA.   While the concept sounds good, it’s not allowed.  The IRS will make you pay tax and remove the RMD proceeds.  Anything left after the RMD can be converted into a Roth IRA – just remember you’ll have to pay the appropriate tax.

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