Common RMD Pitfalls
by Kyle Berg
Imagine this. You’ve worked hard to save every penny you could so that you can finally call it quits and not have to work another day in your life. Your retirement savings have well exceeded the United States household average of $17,000. Now, you are six months into your 70s and Uncle Sam wants a cut of what you have worked so hard to save. So, you have to take a required minimum distribution, or RMD for short. Failing to do so will cost you 50% of the distribution, which is something you want to avoid at all costs.
Lucky for you, you have a Financial Planner that can help guide you through the sometimes tricky world of taking your RMD. Below are some common pitfalls we have witnessed and want you to avoid.
Not taking the appropriate distributions
There are a number of different qualified retirement plans in the marketplace — IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), and 457, just to name a few. It is important to take into account ALL of your qualified retirement plans when calculating your RMD. For most qualified accounts, including 403(b)s and IRAs, if you have multiple accounts of the same type, you can take the entire distribution from one account. But there are some nuances with 401(k)s. With 401(k) accounts you are required to take an RMD based on the amount in each individual’s 401(k) account. So if you have multiple 401(k)s, you will have to keep track and take a distribution from each. Roth accounts are unique in that they don’t require withdrawals during the owner’s lifetime.
Taking your first distribution too early
In the year you turn 70 1/2, you are able to do something you cannot do in any other year. You have the ability to delay taking your RMD until the following year. The catch is, you will be required to take two separate distributions the next year, one for the prior year, which must be taken by April 1, and another for the current year. Timing your first RMD correctly could create a more favorable tax situation. Your tax professional can help you identify a strategy that is right for you.
Taking distributions while you are still working
If you are still working, and are not a significant owner of the company (more than 5%), you are able to delay taking your RMD until the year after you stop working. This is a powerful strategy, since you are able to get extra time for your money to compound and grow tax-free. There is no definition to the phrase “still working,” so in most cases, even if you are working part-time, you can delay taking your RMD.
It’s worth noting that similar to delaying your RMD in the year you turn 70 1/2, if you delay your RMD during your final year of work, you will be required to take two separate distributions the next year. Also, this strategy does not apply to IRAs. So, if you are still working and have IRA accounts you will need to take your RMD.
Dying before taking your RMD
Unfortunately, we are all mortal and we have not yet discovered the fountain of youth. When someone dies, they are still required to take their RMD. If they did not take their annual distribution prior to death, the RMD will have to be taken by the beneficiaries, or inheriting spouse, in the appropriate year.
Missing an inherited Roth IRA RMD
Roth IRAs are different from most retirement savings tools, as they do not require you to take a distribution during your lifetime, and are not income taxable upon withdrawal. That makes them a very powerful investment tool. But if someone were to inherit a Roth IRA the rules change. Distributions are still income-tax free, but beneficiaries are required to take an annual RMD based on their own life expectancy.
At Affiance Financial, we help our clients avoid the pitfalls of RMD errors by discussing them regularly in our meetings and documenting any decisions that are made in our meeting notes. If you are approaching 70 1/2 and would like help strategize your RMDs, give your financial planner a call, we are always more than happy to help.
No client or prospective client should assume that this content serves as the receipt of, or a substitute for, personalized advice from Affiance Financial, or from any other professional.