According the AARP, about 10,000 Americans turn 70½ every day of the year. If you’re in that group, and have money parked somewhere that you’ve identified as a retirement account, chances are you’ll have to start taking a RMD soon.
First, a little background info. We’ve agreed that the Internal Revenue Service (IRS) is responsible for describing and collecting federal taxes from us. It’s up to us to know the rules and to conform to them if we want to avoid penalties. Alternatively, if we are so motivated, we can attempt to argue our position in the Tax Court. Our chances of winning a legal battle over RMDs is slim to none.
It’s the IRSs position that if we have money accumulating in properly defined accounts such as an IRA, a 401(k), a 403(b), or any one or more of several similarly identified accounts, we have not yet paid income taxes on that money. In other words the taxes have been deferred until later under rules that caused said money to be called ‘qualified’ money. And the accounts in which they reside are thought of as ‘qualified’ accounts. Not to be confused with ‘non-qualified’ accounts.
It’s also the position of the IRS that given their responsibility to collect taxes to keep the federal coffers properly filled, they have the ability to impose penalties if you don’t conform to the rules. Which is why you need to understand RMDs so as to not make the IRS angry.
The idea behind qualified accounts is to encourage us as citizens to set aside money from current income such that it will be there to help pay our bills in retirement. Think of it as an incentive, coupled with a penalty if you withdraw money from said accounts too soon. It’s somewhat arbitrary, but the ‘too soon’ age is before you reach 59½ . We’ll ignore that for now.
The rule every one of you are subject to involves reaching age 70½ , also somewhat arbitrary, but the age when if you don’t start taking money out of your qualified accounts, there is a disincentive to ignore the rule. That disincentive is a penalty in the form of additional taxes to be paid.
Since you presumably know your birth date, it’s not hard to figure out the calendar year when you reach age 70½ . That year defines the tax year when if you don’t take out the MINIMUM amount, and pay taxes on it, you’ll make the IRS angry. There’s little to be gained from that.
One caveat is that if you turn 70½ in tax year 2019, for example, you actually have until April 1st of following year to take your REQUIRED MINIMUM and report it as income. That may give you a little breathing room, but it also means you’ll have a second RMD to deal with that following year. Every year after that first year, the formula for your RMD means money has to be taken before December 31st if you want to avoid a penalty.
With the internet now available to virtually all of us, it’s not hard to find an online calculator to tell you how much you have to take. There is a variation you need to be aware of, however, if you have IRAs and 401(k)s.
If you have multiple IRAs, you can aggregate them and have the RMD apply to the aggregation amount. That means the IRS doesn’t care which account the RMD comes from, just that the RMD shows up as income on your tax return.
If you have multiple 401(k) accounts however, you need to calculate the RMD for each one and make the appropriate withdrawal from each. And if you’re still working and contributing to a 401(k), you can delay your RMD from that account until you stop working. Unless you own 5% or more the company, in which case you cannot delay.
A few more useful facts are that you don’t necessarily have to take an RMD in cash. It’s the amount that shows up on your tax return that matters. If you have stock positions in a 401(k) account, you might instead transfer some of those positions to a non-qualified account which will satisfy the IRS.
Another thought to bear in mind is whether you ever made an extra deposit to an IRA that exceeded the MAXIMUM amount allowed. If you did, that was a ‘non-qualified’ deposit; you’ve already paid taxes on it. But the IRS doesn’t keep track of that, meaning it’s up to you to determine how much of any given withdrawal is qualified and how much is non-qualified.
The IRS says each withdrawal from a mixed account always consists of two parts, the qualified part and the non-qualified part. That means some of your withdrawal is tax-free and some of it is taxable. You have to make sure you’re taking enough each year to satisfy the RMD for the qualified amount.
If you discover after the fact that you failed to take a timely RMD, don’t just send the IRS a check. Fill out a form that describes your mistake, and they might just waive the penalty.
Lastly, it’s easy to get confused if you are not financially sophisticated and approaching senior citizen status. For example, I’ve had clients who get all caught up in the RMD and age 70½ rules and allow themselves to use those ages when it comes to deciding when to start taking Social Security. They ask me if they can wait until 70½ to sign up for Social Security. The answer is yes you can but why would you forfeit six months of Social Security benefits when doing so gives you absolutely no advantage.
Tony Kendzior \ June 20, 2019