At the age of 73, you are required to begin taking money out of your tax-deferred retirement accounts, like the traditional individual retirement account (IRA) or a 401(k) plan, in an amount known as a required minimum distribution (RMD). However, making a mistake with significant monetary repercussions is far too simple.
To determine the minimum distribution that must be made, a series of calculations and categorizations must be performed first. If you make a mistake on any of them, you might withdraw less than necessary, resulting in a hefty tax penalty. If you owe money to the IRS and don’t pay them on time, they’ll hit you with a 50 percent excise tax.
Because of this potential downside, experts advise clients to err on the side of caution by withdrawing slightly more than the calculated amount when making distributions. However, if you remove too much money from your accounts, you could pay more taxes and reduce your savings in the long run.
Here is a rundown of some frequent RMD mistakes and the trouble they can cause, most often with taxes.
Putting Off Your Initial RMD
Generally, those born before 1960 have until they turn 73 to begin taking RMDs, while those born after 1960 have until the year they turn 75 to start taking RMDs. The IRS allows you to delay your first RMD until April 1st of the following year, acknowledging that new “distributors” may need more time to prepare for the withdrawal process.
The convenience may outweigh the potential benefits in terms of your finances. If you postpone the first RMD payment until the end of March, you’ll have to take two RMDs in fewer than 12 months: the one you delayed and the one that’s usually due on December 31st.
Your accounts may require you to take out two sizable taxable withdrawals in the same year if your RMDs are high. Depending on your MAGI, this could cause you to fall into a higher tax bracket and make you responsible for the Medicare surcharge (MAGI).
Do not request an extension under these circumstances. Instead, begin taking withdrawals by December 31st of the year you turn 73 to distribute them evenly between the two years.
Miscalculating the True Market Value
Annual RMDs are calculated by dividing the FMV of your retirement account as of the prior year’s end by the distribution period that applies to that year’s RMD calculation. You can determine this time frame using the IRS’s published life expectancy tables, which are adjusted for your age. By the end of the following year, on January 31st, the custodian of your retirement accounts should have provided a report of your FMV.
Nonetheless, it can only accomplish that goal with the data at its disposal.
Because there is only sometimes sufficient paperwork, It can be challenging to make this calculation if there is little data available on the portfolio’s value at the end of the year (due to missing statements, accounts being moved, or difficult-to-value assets).
Changing your circumstances after your FMV was calculated based on year-end data may also result in a revised RMD. However, the Tax Cuts and Jobs Act of 2017 made it less common for lawmakers to make last-minute adjustments. Recharacterization, the process of reverting a Roth IRA to a traditional one to avoid the one-time, large tax bill associated with the conversion, was outlawed by the law in question.
However, you must inform your custodian of any yearly changes that might affect the RMD you must make by December 31st.
Compliance with Required Minimum Distributions Through a Variety of Plan Types
If you have more than one IRA or 403(b), you can take your required minimum distribution (RMD) from any of them instead of multiple smaller distributions. However, you cannot transfer funds from a 403(b) to satisfy an RMD for an IRA or vice versa. Furthermore, this consolidation is not possible with 401(k) plans.
To satisfy the RMD requirements of one type of retirement account, money cannot be moved from another tab in the portfolio.
Required Minimum Distributions and Inherited IRAs
If you are the beneficiary of more than one individual’s inherited IRA, you can roll the required minimum distributions (RMDs) for all those accounts into a single inherited IRA. However, you can’t pool RMDs from multiple inherited IRAs for the same person’s benefit.
Additionally, distributions from traditional IRAs that you own cannot be used to pay taxes on inherited IRAs. Here is an illustration to help clarify:
When Pam’s Aunt Lucy passed away, she received an Individual Retirement Account, and the required Minimum Distribution from the inherited IRA is $6,000. Pam has her retirement account (IRA); the required minimum distribution (RMD) from that account is $10,000.
The RMDs Pam must take from both his and inherited accounts must be added separately. The required minimum distribution (RMD) amount must be paid out of the corresponding account.
Withdrawals and Roth IRAs
Also, keep in mind that distributions from inherited Roth IRAs are subject to a different set of regulations. (There are no Required Minimum Distributions from a Roth IRA while the account holder is still alive.) Specifically, distributions may be necessary. Roth IRAs owned by individual investors are exempt from RMDs, but Roth IRAs received as an inheritance are.
The requirement to take RMDs out of a Roth IRA does not apply if the beneficiary is a spouse. Generally, if you inherit money from someone, you’ll need to start taking money out of the account as soon as possible. You don’t have to withdraw a certain amount of money every year or stick to a specific schedule, but you do have to empty the account within ten years. 6 Minor children, disabled individuals, and heirs younger than ten years after the decedent’s death are among the special categories of beneficiaries who have additional choices, such as basing the RMDs on their life expectancies.
401(k)s and Required Minimum Distributions
The required minimum distributions (RMDs) must be distributed equally among your 401(k) accounts. Like IRAs, 401(k) plans from previous employers require required minimum distributions, but you’ll need to figure out the exact amount for each plan before withdrawing any money.
Retired Minimum Distributions for You and Your Spouse
Retirement accounts are not among the types of financial assets that can be held jointly by a married couple. Each of these items needs to be owned independently, and taking RMDs is an individual’s responsibility.
Unfortunately, many married couples, especially those who file taxes together, fail to recognize this distinction. Because they file a joint tax return, they incorrectly assume that a required minimum distribution (RMD) from one spouse’s account will cover the RMD on the other.
Imagine you and your spouse are both required to take RMDs, and you decide to do so jointly by withdrawing the total amount from your spouse’s IRA. The tax repercussions of withdrawing your required minimum distribution (RMD) from your spouse’s IRA are unfavorable.
The Internal Revenue Service will view you as having neglected your RMD obligation. The government agency can charge an excise tax of up to 25% of the RMD amount. As a result, your spouse will have “overdistributed” from her account and will owe more in taxes. If you fix the mistake in your tax return immediately, the rate will be lowered to 10%.
Simply Put
Eventually, after years or even decades of saving, you will need to begin withdrawing and taxing the funds from your retirement accounts. RMDs are required to be taken at age 73 starting in 2024 and at age 75 beginning in 2033. If you make a mistake, it could have serious financial repercussions.