Is age 70 fast approaching? Do you own a traditional IRA or a 401(k) plan? If so, 70½ could be an important age for you. That’s the age at which required minimum distributions (RMDs) begin.
Traditional IRAs and 401(k) plans are popular retirement savings vehicles because of their unique tax treatment. You contribute to your account with pretax dollars and allocate your contributions according to your goals and risk tolerance. Your contributions then grow on a tax-deferred basis, which means you don’t pay taxes on growth as long as the funds stay inside the account. That means your entire IRA or 401(k) balance may be untaxed.
Those dollars can’t stay untaxed forever, though. Eventually, the IRS wants to tax those funds. When you’re age 70½, the IRS mandates that you begin taking taxable distributions from your traditional IRA and 401(k). The exception to this rule is the Roth IRA. Roth distributions are already tax-free, so the IRS doesn’t mandate an age at which you have to begin distributions.
Since RMDs impact your income and your tax liability, it’s helpful to have a plan in place. If you are approaching age 70 and haven’t yet created your RMD strategy, now may be the time to do so. Below are a few common questions and answers to help you plan:
When do RMDs begin?
Technically, age 70½ is the RMD starting point. However, the formula for when distributions start is a bit more complex. You actually have until April 1 following the calendar year in which you turn 70½ to take your first RMD from an IRA.1
RMD rules for 401(k) plans are a bit different than those for traditional IRAs. If you’re retired, the rules are the same as they are for an IRA. If you decide to work past age 70½, however, you can delay RMDs from your employer’s 401(k) plan until April 1 following the calendar year in which you retire. Keep in mind that this applies only to the 401(k) from your current employer, not balances from previous employer plans.1
How much will you have to withdraw?
Your RMD amount is based on two primary factors: your account balance and your age. The IRS has a helpful worksheet you can use to estimate your distribution. The agency assigns a factor for each age, starting at 70½. To estimate your amount, take your Dec. 31 balance from the previous year and divide by the factor for your current age.
The factors get smaller as you get older. This means your withdrawal will increase relative to your balance each year. If you live into your 90s, you could withdraw a significant portion of your balance each year as an RMD.2
If you have a spouse who’s at least 10 years younger than you, your distribution formula is different. You can use a joint schedule that utilizes different factors. The same is true if you’re an IRA beneficiary. You may want to consult with a financial professional to get an accurate distribution estimate.
What if you have multiple IRAs or 401(k) plans?
It’s common for retirees to have multiple IRAs and 401(k) plans. That’s especially true if you changed jobs several times. You may have opened a new account with each job change. The RMD rules regarding multiple accounts are slightly different for IRAs and 401(k)s.
If you have multiple IRAs, you can simply take one distribution for your total IRA balance. You don’t have to take a separate RMD for each account. As long as you’re taking the appropriate total RMD for your IRAs, it doesn’t matter which account the distribution comes from.
If you have multiple 401(k) plans, the rules are a bit different. You must take a unique RMD from each 401(k) plan. That could be complicated if you have multiple 401(k) balances from former employers. For simplicity’s sake, you may want to consider consolidating those balances into an IRA. That could reduce the risk that you accidentally forget to take an RMD.
What happens if you don’t take your RMD?
If you miss an RMD, either accidentally or intentionally, you could face a 50 percent excise tax on the skipped amount.1 However, the IRS does offer corrective programs. If you miss a distribution, you may be able to work out a plan with the IRS to make up the distribution and avoid the penalty. Again, a financial professional can assist you.
Ready to develop your RMD strategy? Let’s discuss it. Contact us today at J. Harris Financial. We can help you analyze your accounts and create a plan. Let’s connect soon and start the conversation.
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