Approaching 70? Don’t miss the RMD deadline!

To avoid a hefty penalty, you’ll need to stay on top of required minimum distributions.

Last week I met a busy professor who, by her own admission, isn’t great at keeping track of her retirement accounts. Though in her seventies, she has no immediate plans to retire, and still puts money into her 403(b). Unfortunately, she was recently hit with a 50% penalty for money she’d neglected to take out of her other accounts, including a traditional IRA and an old 401(k). An error of omission, you might say, but one I see happening all the time—among retirees and active professionals alike.

What are RMDs?

As a tax expert, one of the methods I use to get half-hearted savers to fall in love with 403(b) plans and IRAs,is to point out the immediate tax break they offer. There are few things as alluring as a vastly reduced tax bill.
But like karma, the time to pay your fair share to Uncle Sam must come around eventually. This usually happens way in the future,when you retire and start turning that tax-deferred money into income.
For many people it makes sense to leave “retirement” money untouched, even beyond retirement. A spouse’s pension might be covering all expenses, or that IRA might be earmarked for future medical expenses. Whatever the reason, you cannot put withdrawals off forever: The day will come when you need to start paying your share of the taxes you’ve been deferring.
And the way the IRS gets its money back is by requiring minimum distributions, starting the year you turn 70½ or retire, whichever is later.

If you fail to pay a required minimum distribution (RMD), you’ll be penalized to the tune of 50%. In other words, you just cannot afford to miss one.

Note: If you have a Roth IRA, you don’t need to worry about RMDs, because none are required during your lifetime. The same is not true, however, with a Roth 403(b) or 401(k)—minimum distributions do need to be taken from these accounts.

How RMDs are calculated

Quick Facts
To calculate your RMD amount, take the balance of your retirement account as of December 31st of the previous year, and divide it by your “life expectancy factor” or “distribution period.” They can easily be found in this table . If you take it at 70½, your first RMD works out to be 3.65% of your balance, a percentage that increases each year.
You’ll need to do this calculation for each of your IRAsand 403(b)s; basically all accounts that have pretax money in them (for which contributions were taken from your gross income)—as well as for any Roth (after-tax) 401(k)/403(b)s. For your IRAs, add up the total for all these minimum amounts, and withdraw that amount from any one or more of your IRAs—it doesn’t matter which one.
The same goes for multiple 403(b) accounts—you may aggregate all amounts and withdraw the total from just one account. You don’t have to take a separate RMD from each account (as is the case with other defined contribution plans, such as a 401(k) plan, where RMDs have to be taken from each separate plan; they cannot be aggregated).
And it doesn’t matter when you make the withdrawals—as long as the full RMD amount is taken by December 31st. RMDs will then be due every year thereafter.


Missing an RMD is no joke

If you fail to withdraw the required amount in any given year, you‘ll face a 50% penalty from the IRS on however much you fell short. So, let’s say your RMD is $5,000 in year X and you only take out $4,000 by December 31. You will owe the IRS 50% of $1,000, the amount you failed to take out. RMDs are serious business, so it’s crucial you know your RMD amount and plan accordingly.
During the first year the RMD deadline is extended, giving you some leeway. So, suppose you turn 70½ in 2018: You’ll need to take your first RMD by April 1, 2019. If you choose to wait until the last minute, be aware that your next RMD is due December 31, in the same year. Meaning, you’ll be taking two RMDs in a single tax year.


What if you haven’t yet retired?

People are increasingly working beyond their 60s. The good news for still-employed seniors is that they won’t have to take a single distribution from their current employer plan until they retire. But bear in mind, any accounts you have with previous employers, or traditional IRAs, will be subject to RMDs.This is something my professor friend had neglected to take into account.


A financial advisor can make it simple.

I meet a lot of professors who work beyond age 70½ and usually they have retirement accounts from institutions they previously taught at. Figuring out the RMD for each of these accounts can be a hassle. So, if any time is ripe for consolidating accounts, it’s around that 70th birthday.
A financial advisor can determine how much you owe, whether you can afford to defer those RMDs, and what your options are in terms of consolidation. Converting everything to a Roth IRA, for example, is one way to defer RMDs for the rest of your life, but can you afford the immediate tax bite on that $1 million dollar nest egg? He or she can help you determine what is in your best interests, and alert you to unanticipated tax consequences: Deferring your RMDs by consolidating everything into your current employer plan, for instance, may make your RMDs so high that when you finally take them, they push you into a higher tax bracket.


RMDs can be a pain in the neck.

Many retirees ask me how to get around the issue of having to withdraw money that they would rather leave to grow. Luckily, there’s an increasingly popular strategy to let them do just that.
If, based on current tax rates, your projected future income, and other crystal-ball techniques, you decide it’s a good idea to indefinitely defer RMDs, you may want to do a conversion. Converting all your taxable accounts to a Roth IRA may make sense in certain situations. But the conversion doesn’t have to be on the entire balance of your traditional IRA. As with any Roth conversion, the big drawback is, you’ll have a huge tax bill upfront.
A good rule of thumb: Don’t convert any money you can’t afford to pay federal and state taxes on. To convert just $10,000, you’ll need to come up with several thousands of dollars before Tax Day.
The benefits can be considerable. For example, prepaying your income tax with a Roth conversion reduces the size of your estate tax liability at death. Roth conversions can be a powerful tool in estate planning, something worth mulling over with your financial advisor.
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January 8, 2018
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