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Avoid a 50% Tax Penalty, Take Your RMD!

November snuck up on us and, BAM!, here we are again, facing the Holidays and that bane of the retired man’s existence, the Required Minimum Distribution, or RMD. Baby Boomers, defined as the generation born starting in 1946, know that any Boomer born in the first half of that year will turn 70-1/2 this year.  The rule-makers in Washington, D.C. have decreed that these people must start draining their qualified retirement accounts this year, because they have been allowed to defer income taxes on those assets about long enough, thank you!  (Why they decided 70-1/2 is beyond my speculative ability.)

The process of paying your “fair share” to the U.S. Treasury is called “Required” (the “R” in RMD) because it is!  The “M” stands for minimum, which means the faster you take the money and pay taxes, the better.  They want your money, and they believe you have withheld it long enough.  The penalty for not taking the money out of the account is the most serious tax penalty we know of, at 50% of the amount not withdrawn.  Of course, this is not an either/or tax, it is a “both” tax.  Here’s the formula: Ordinary income tax + 50% penalty tax = you don’t have much left!

Knowing that you are required to take a distribution is only the beginning of the process.  Understanding the rules can help you plan a smoother retirement income process.  While there is a very complex set of rules in the Tax Code, I’ll simplify to the extent possible.  Remember, we never tell you exactly what to do, but we like to tell you what can be done, and where to get help if you need it.

Let’s do some vocabulary, as it is critical to understanding RMDs:

  • Qualified means that taxes are not assessed currently, but rather postponed to a later date
  • Retirement Account means any one of company-sponsored or individually-owned accounts that are Qualified
  • Roth refers to a number of account types that are not generally taxed when paid out, because contributions are made from after-tax earned income
  • Traditional generally refers to retirement account that provide a current tax deduction to the owner or participant, in return for taxes levied upon withdrawal
  • Owners are individuals who open and maintain their own retirement accounts
  • Participants generally refer to employees of organizations that sponsor group retirement accounts
  • Custodian refers to companies that actually hold the monies in your accounts, and provide the service of buying and selling actual investments, such as equities, bonds, mutual funds, and Exchange-Traded Funds (ETFs), all at your direction, or that of your advisor
  • The “still working” RMD exemption applies to some, but not all, types of accounts, and will be addressed next week

In its simplest form, the RMD works just like any other single transaction.  Every year after age 70-1/2, the owner or Plan participant receives a distribution from the retirement account.  The calculation of the minimum (there is no legal maximum) is set by law, and easily derived.  Timing the RMD is simple; it must occur in the calendar year to which it applies.  No make-ups or do-overs need apply.

There is, however, some flexibility in taking the RMDs, both in timing and among various retirement accounts.  As to timing, the RMD can be taken on any one day, or meted out during the year; the calendar is the only restriction.  For those who estimate their taxes and file quarterly tax deposits, all RMDs are treated as if taken on December 31, so there is no penalty for under-paying estimates in any given quarter.

The process gets somewhat more complicated when the owner has more than one retirement account, which is very common these days.  For now, we will eliminate discussion of Roth accounts, as they are exempted from RMDs until inherited by a beneficiary.  Next week we will cover the situation where one Owner or Participant has more than one account, and/or more than one type of account.

For people who are uncomfortable with the rules, or who simply don’t have the time or interest required to do the planning, we suggest using a fee-only Certified Financial Planner, such as Van Wie Financial.  Doing so can enhance your chances of managing your retirement funds, and hence your lifestyle in later years.

Van Wie Financial is fee-only, for a reason.