The Lowdown on Required Minimum Distributions
While its tax deferral is a powerful incentive to save, the Traditional Individual Retirement Account (IRA) was never meant to shield those savings from the IRS indefinitely. Consequently, account owners are required to start withdrawing a certain amount from their Traditional IRAs each year once they reach age 70½. These withdrawals, called required minimum distributions (RMDs), are governed by a rather complex set of rules and regulations. Below are a few of the questions you may have, along with a general description of the applicable rules governing RMDs.
1. How are RMDs calculated?
When determining your RMDs, here are some facts to keep in mind:
- Your RMD is calculated by dividing the fair market value of your IRA as of December 31 of the prior year by a life expectancy factor that is determined according to Internal Revenue Service Life Expectancy Tables
- Any withdrawals from a Traditional IRA, including RMDs, are added to ordinary income and taxed accordingly
- During your lifetime, you will generally use the Uniform Lifetime Expectancy Table to determine your life expectancy, with one exception. If your spouse is more than 10 years younger than you, and is your sole beneficiary, then your RMD will be determined based on your joint life expectancy
2. Depending on when I take my RMDs, could I be forced into a higher tax bracket?
The first RMD must be made by April 1 of the year after you reach age 70½. This is called your required beginning date (RBD). The deadline for all subsequent RMDs is December 31. Even though the first RMD may be postponed until the year after you turn 70½, it’s often smart not to wait. By delaying the distribution, you’ll be forced to take two RMDs in the year you turn age 71½. Besides paying income tax on two withdrawals, the added income may also nudge you into a higher tax bracket.
3. How may I calculate my minimum withdrawal if I have more than one IRA?
- If you have several IRAs, you must calculate the RMD separately for each account
- You can allocate RMDs in any combination you want. If one IRA is invested in a depressed market sector, you can take the entire amount from your other IRAs. Keep in mind that if you DO NOT want an RMD withdrawn from one of your IRAs, let your financial institution know. Some IRA providers automatically transfer RMDs into a separate non-IRA account to help you avoid possible penalties
- Spouses—even though they file taxes jointly—must do their RMD calculations separately
4. What do I need to know if my spouse died and I’m the IRA beneficiary?
You may elect to roll over the IRA to your own IRA account, and thus treat it as your own. Upon your attainment of age 70½, you would begin your RMD withdrawals. Or, if you are the sole primary beneficiary, you may choose to leave the IRA in your deceased spouse’s account, and treat it as a beneficial account. Then, RMDs may be delayed until your deceased spouse would have attained age 70 ½. At that time, RMDs will be calculated based on your own single life expectancy.
5. What is the risk in not taking my RMD on time?
Missed RMD withdrawals are subject to a penalty tax of 50% of the amount that was required to be taken but was not. The penalty is applicable every year this amount remains in the IRA.
It is important to note that the above information is for general information only and everyone’s individual circumstances are different. As with all aspects of IRA distribution planning, it is critical to consult a qualified tax or legal advisor.
This week, review your IRA accounts. Start thinking about when you need to take your RMDs and how it may affect your overall financial picture.
This material is provided for general and educational purposes only, and is not intended to provide legal, tax or investment advice, or for use to avoid penalties that may be imposed under U.S. federal tax laws. Contact your attorney or other advisor regarding your specific legal, investment or tax situation.
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