3 Investing Facts About Required Minimum Distributions You Need to Know - June 04, 2020

Neglecting to withdraw a required minimum distribution (RMD) from an IRA by the due date brings about a painful tax code penalty: 50%. Yes, you read that right. If you are supposed to withdraw at least $4,000 and (uh oh!) did not do as such, you have to write the IRS a check for $2,000. Keep in mind that on January 1, 2020, the RMD rules were modified.

In case you're like most investors, you're probably trying to build a financial portfolio that is solid enough to guarantee a comfortable retirement. Among retirement financial planners, this is known as the "accumulation phase." In this stage, your objective is to carefully invest by selecting stocks with long-term potential for your retirement nest egg. For example, you might choose Lockheed Martin (LMT), which is a current top ranked dividend stock.

But that's just half of retirement planning. The second part, the "distribution phase," sometimes gets overlooked even though it can be more fun to think about. That's because the distribution phase is where you determine how to spend your hard-earned assets.

Planning for the distribution phase is the time where you may make decisions about where you'll want to live in retirement, whether you'll want to travel, hobbies you may pursue, and other decisions that will affect your retirement spending.

Along with those choices, you need to be mindful of the RMD, because it applies to the majority of retirement accounts. This IRS rule requires you to withdraw a specific minimum amount from any qualified accounts you have when you reach a certain age--previously it was 70 1/2, but beginning in 2020, it is 72.

Why does the IRS require you to start taking your money out? It's simple - they want to make sure they get their tax. If this rule didn't exist, people could live off other income and never pay tax on their retirement investment gains. Then, that money could be left to family or friends as an inheritance without the IRS collecting any taxes from you.

Key Facts to Know About RMDs

Which types of retirement accounts have RMDs? Qualified retirement accounts like IRA accounts, 401(k)s, 457 plans and other tax-deferred retirement savings plans like a TSP, 403(b), TSA, SEP, or SIMPLE IRA plan require withdrawals in retirement.

When do I need to begin withdrawals? For most accounts, you should take your first distribution by April 1 of the year following the calendar year in which you turn 72. If you retire after 72, you must withdraw your first RMD from your 401(k), profit-sharing, 403(b), or other defined contribution plan by April 1 of the year following the calendar year that you retire.

For each year after your required starting date, you must take your RMD by December 31. Note that you don't need to take an RMD on a Roth IRA since you covered taxes before contributing. Other varieties of Roth accounts require RMDs. But, there are approaches to avoid them - for instance, you can roll your Roth 401(k) into your Roth IRA.

What will happen if I neglect to take my RMD? If you don't take an RMD, or don't take a large enough distribution, you are liable for a 50% tax on the amount that was not withdrawn in time.

How much cash do I need to withdraw? To figure out a particular RMD, you should divide your earlier year's December 31st retirement account balance by a "distribution period" factor dependent on your age.

Here's an example to give you an idea of the math: Ann is 71 and will take her first RMD in the year following the year she turns 72. Her IRA balance toward the end of the preceding year was $100,000. Her "distribution period" factor is 27.4. Dividing $100,000 by 27.4 equals $3,649.63. This is the amount Ann is required to withdraw for her first RMD.

Learning about the "distribution phase" is just one aspect of preparing for your nest egg years.

To learn more about the tax implications of retirement spending - and much more about retirement planning - download our free guide: Retirement Made Easy.

You'll find useful, detailed steps to help you navigate both the accumulation and distribution phases of retirement planning. Get Your FREE Guide Now
 
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