Being in the financial services industry I often find myself assuming that everyone knows exactly what I am talking about. I have to slap myself occasionally because the reality is unless you’re dealing with these things on a regular basis; it’s hard to keep up with the terminology.
The reason I am bringing this up is because this time of year the word “Required Minimum Distribution” or RMD is popular. The funny thing that I find about this term is that everyone that has an IRA knows the words but are so often EXTREMELY confused on what it is and how it works. So today I will attempt to give you a very basic understanding of the term.
A Required Minimum Distribution, or RMD, is generally a minimum amount a retirement account owner must withdrawal from such account once they reach age 70 1/2. Now remember that RMD states a minimum amount of withdrawl. You can always take out more than the minimum; you just can’t take out less without incurring a penalty.
RMD’s must be taken beginning in the year you turn age 70 1/2, but for your very first withdrawal, you have up until April 1st of the year after you turned age 70 1/2. This is often the part that becomes confusing to most people. All other withdrawals must occur each and every year, and must be taken out by December 31st. In addition, if you wait to take your first withdrawal until April 1st of the of the year after you turn 70 ½ then you must take 2 distributions that year. Your first on or before April 1st, then your second before December 31 of that same year.
There are some exceptions to this. For example, if a person is still working beyond age 70 1/2 and they have a workplace retirement account like a 401k, then they do not have to take the RMD from the 401k. Once this person retires, then RMDs must be taken from that 401k plan. If they have an IRA, they must take it at age 70 1/2 whether they are working or not.
How Are Required Minimum Distributions or RMD’s Calculated?
RMDs are calculated for each IRA that a person owns, and is based on the December 31st balance of the previous year. The IRS has a life expectancy factor, or chart, which takes a number that gets divided into an owner’s IRA account balance. That number becomes your amount for dostribution.
Now another issue that the IRA owner does not understand is that say you hold multiple IRA accounts for the same person, The IRS does not care from which account you take your RMD amount from. All that they care about is that you took out the entire RMD. Whether you take the entire RMD from one account or split it up and take it from 10 accounts does not matter. What matters is that you take the entire amount corresponding to that specific year.
But what if you don’t want to take your IRA withdrawal? After all, why start withdrawing from your IRA, especially if you don’t need the money?
Well, here’s why you NEED to:
If an IRA account owner decides not to withdraw their RMD, withdraws less than the full amount of the RMD, or doesn’t withdraw the RMD by the deadline, the amount not withdrawn is taxed at 50%. Ouch! Uncle Sam makes sure you don’t mess with him on this one, and the last thing you want to do is owe the IRS back taxes!
Well I hope this helps you understand RMD distributions a little better. And as always remember to Ignore Wall Street and Get on with your life.
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