RMDs—or Required Minimum Distributions—can be a retirement nightmare. While the idea of withdrawing the required amount of savings from your tax-deferred retirement account may sound pretty straightforward, unfortunately, it is often anything but. That’s particularly true if you are lucky enough to have multiple accounts that each require an RMD.
Tax-deferred accounts are an important component of your portfolio. You save tax-free during your high-earning years and defer the taxes on that money until retirement when, in theory, you will likely pay less tax on every dollar. For retirement investments, compounded tax savings can be substantial.
The catch, of course, is the dreaded Required Minimum Distribution. RMDs are designed to ensure that the IRS gets its fair share of taxes on those well-saved dollars starting when you become age 70½. The rules for RMDs, detailed in a 63-page tome of IRS legaleese called Publication 590-B, are complex—to say the least. To get you started, here are the basics:
- Your RMD is the amount you are required to withdraw and include in taxable income each year. The key is “minimum” required amount. There is no maximum amount—you can withdraw and pay tax on as much of your money as you wish. But our clients are wise to “stretch” their withdrawals to defer taxes over their lifetime, and often the lifetime of their heirs.
- You must begin withdrawing from your traditional, SEP, and SIMPLE IRA accounts by April 1 following the year you reach age 70½. Annuities, 403(b), and 401(k) accounts have their additional requirements. Every year after that, you must continue to withdraw the RMD amount based on the IRS tables and your “age factor.”
- The IRS provides tax tables to calculate your RMD, but different situations require different calculation tables. If your spouse is the only beneficiary on your IRA account and is more than ten years younger than you, one table applies. If your spouse is the only beneficiary and is the same age as you, you use a different table. A third table is used if you inherit an IRA from someone else. In this case, you have to start taking distributions in the calendar year after the owner dies.
- If you have multiple accounts, the RMD for each account must be calculated separately. While you can often take the total RMD amount from one account, that’s not always the case. Depending on the type of account, you may have to take an RMD from each account; a lump sum withdrawn from a single account may not satisfy the requirements even if the cumulative amount is equal to your required minimum.
- Failing to take your RMD—or failing to make it correctly—can result in a penalty tax of 50% for any amount not withdrawn. If you have $1 million in your IRA, at age 70½, your RMD would be $36,496 (at least according to one table!). If you fail to take your distribution before the end of the year, you will owe an excise tax of $18,248 ($36,476 x 50%) in what the IRS calls “Additional Tax on Excess Accumulations.” Even if you make an RMD but understate the amount, you are still subject to the 50% penalty on the underpaid amount.
It pays to get your RMD right every time! Many retirees make mistakes every year—and pay dearly for them. In the not-so-recent government report on the subject (from March 2010), an estimated 255,498 individuals had failed to take their RMDs from their IRAs. That’s just one type of tax-deferred account that requires RMDs. There’s little doubt that those numbers have risen in the past decade as baby-boomers have been crossing the age 70½ threshold.
So, what happens if you miscalculate an RMD—or you forget it entirely? Luckily, the IRS isn’t entirely heartless. They do offer you a way to have all or part of the 50% penalty waived. But, as you can imagine, requesting—and ultimately receiving—that waiver is a complicated process, too. A waiver is only possible if you can show that the shortfall in distributions was due to “reasonable error” and that you are taking “reasonable steps” to correct the problem. To request a waiver, you must file IRS Form 5329 and attach a statement of explanation. Waivers are typically granted when people neglected to take distributions because of physical illness or dementia. Cognitive issues, of course, complicate the issue since anyone so affected is unlikely to be able to make the request anyway! Even someone in perfect health is likely to find the process challenging because of insufficient and even incorrect instructions.
What’s the solution? Careful and professional attention. Retirement plan distributions are complicated, and retirees are facing this complexity at a time of decreasing mental acuity associated with aging. Even though there are remedies, the remedies require complicated actions. To make sure you do it right the first time, rely on a trusted professional—preferably a Certified Financial Planner™ (CFP®) who has insight into your entire financial life and every one of your tax-deferred accounts. (For more on navigating the challenges of aging and money, see my blog post, Aging parents? Offering help early can ease the way.) Working with a CFP professional who knows your situation and the nuances of RMDs ensures your distributions are right for every account and every year. The peace of mind and assurance of avoiding costly mistakes will be worth every penny!
 “A Service-wide Strategy is Needed to Address Growing Noncompliance with IRA Contribution and Distribution Requirements”, Treasury Inspector General for Tax Administration, March 29, 2010.