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What are the Required Minimum Distribution Rules for my IRA?

“Avoid This 50% Tax Penalty in 2015”

This is one penalty you’ll want to avoid.  If you (or someone you know!) are age 70½ or older this year, don’t forget that you must take a Required Minimum Distribution (RMD) from your retirement accounts before December 31st of this year.  The federal penalty for failing to do so is 50% of the amount of the distribution you should have taken.

There are a couple of exceptions to the rules:

  • If you turned 70½ this year, you can postpone your 2015 RMD until April 1, 2016. If you do wait, you’ll also need to take your RMD for 2016 by December 31st, 2016.  In other words, you’ll have to take two RMDs in 2016.
  • If you’re still working (assuming you don’t own more than 5% of the company), you can postpone RMDs on your 401k (or similar company retirement plan) until the year you actually retire. But you must still take RMDs for other retirement plans such as IRAs or prior employer 401k plans.

People often ask me, “Why does the government have a law requiring RMDs?”  The simple answer is, “Because they want their money!”  Your RMDs are taxed to you as ordinary income and Uncle Sam would rather get his tax money sooner rather than later.

I find many age seventy-plus clients do not need the money from their retirement accounts.  Here are some of the options you might consider:

  • If you are still working (and don’t own more than 5% ownership of the company), see if your company retirement plan allows you to roll-up your IRA into the company plan. By doing so, you’ll effectively postpone RMDs until the year you retire.  Many professions such as law, insurance, and accounting lend themselves to remaining ‘active’ as employees well beyond normal retirement age.
  • After setting aside funds for payment of taxes on your RMD, invest the money tax free bonds or bond funds so as to avoid (or minimize) income taxes on interest earned.
  • After setting aside funds for payment of taxes on your RMD, invest in dividend-paying stocks (or similar stock mutual funds) which typically have much lower income tax rates than investments producing ordinary income. Federal income tax rates on dividends are typically 15% but can be as high as 23.8% while the maximum rates for ordinary income are 39.6%.
  • Transfer your RMD directly to your favorite charity. In past years, Congress has extended the law allowing RMDs to be paid directly to a charity.  While they have not yet extended the law for this year, many expect them to do so.  Ask your IRA custodian to have your RMD check made payable to your favorite charity of charities.  If Congress extends the law you’ve simplified the reporting process.  If they don’t extend the law, you’ll report your RMD on your tax return and take an offsetting charitable deduction on your return as well.  Consult with your tax advisor before implementing this strategy.

Caution #1.  If you have multiple IRA accounts, you can calculate your RMD based on the total of all accounts and take your RMD from any one or combination of those accounts.  For any 401k plan (or similar type plans), your RMD must be both calculated and taken from each plan separately.

Caution #2.  I often hear people say, “I never pay any taxes until they are due!”  However, when it comes to your IRA account, we’ve found that in many cases, your smartest move is to withdraw some funds from your IRA each year before your RMD date if you can get it out in a lower tax bracket than your expect to be in once you reach age 70½.  The best way to determine this is to do a ‘trial tax return’ before the end of the year to determine your estimated effective tax rate and compare that rate to your estimated effective tax rate at 70½. Your tax advisor can easily help you with this.

Finally, even if you have not yet reached age 70½, I bet you know someone who has.  Be someone’s hero and give them a copy of this information.