As you begin to approach retirement, saving for the future has always been a priority. These funds cannot stay in your account indefinitely, which means you will need to start taking withdrawals. These withdrawals are referred to as required minimum distributions. In this blog, we will dive into what a required minimum distribution is, how to calculate your withdrawal as well as what retirement plan accounts that it applies to.
What is a Required Minimum Distribution?
Simply put, a required minimum distribution or RMD is the amount of money that must be withdrawn from your retirement plan. As of 2020, retirement plan participants must begin withdrawing funds at age 72. The previous age requirement was 70 ½.
RMD rules apply to tax-deferred retirement accounts such as traditional IRAs, rollover IRAs, SIMPLE IRAs, SEP IRAs, as well as most 401(k) and 403(b) plans. However, RMDs do not apply to Roth IRAs as contributions to these accounts are with after-tax dollars.
Calculating and Withdrawing Your RMD
Required minimum distributions act as a safeguard against people who believe retirement accounts will get them out of paying taxes. To calculate your RMD, you will begin by dividing your retirement account's prior year-end fair market value by the applicable distribution period or life expectancy. The IRS also has an RMD worksheet that you can follow to determine your annual withdrawal.
The deadline for taking your RMDs is December 31. If you miss the deadline, the IRS may fine you a 50% excise tax for any errors.
Common RMD Mistakes
When it comes to withdrawing your RMD, it seems simple enough, but one mistake can have serious consequences. To avoid calculation errors and hefty fines, we compiled some of the common mistakes that are made as well as how to avoid them.
1. Delaying your RMD
While RMDs must be taken by Dec 31 of each year, the IRS allows new distributors to defer their first RMD until April 1st of the following year. While it may sound convenient to delay the process and prepare, holding off that first payment will mean that you need to withdrawal your RMD twice the following year–April's and December's. While it is a personal choice, we recommend spreading the payments over the course of both years, but you should always speak with your tax professional on what is best for you.
2. Incorrect Fair Market Value
In order to calculate your RMD withdrawal, you need to understand what your account’s fair market value is for the previous year. The custodian of your retirement accounts typically provides a report of your FMV by Jan 31st of the year following. In order to determine your FMV, you will need this information from your custodian to be able to calculate your RMD.
3. Combining RMDs with Spouse
Many married couples choose to be joint owners of their assets, however, retirement accounts should not be included. Retirement accounts are held individually and each person is responsible for withdrawing their RMDs. If you take a single RMD out of one retirement account, then you will be left with a hefty excise tax from the IRS, as they believe that you missed the RMD period and that the spouse overcontributed. In order to avoid this, it is important to remember that retirement accounts are separate financial assets and that RMD withdrawals must be calculated and made separately.
4. Mixing Plan Types to Meet RMDs
If you have multiple retirement accounts, you cannot reach across your portfolio and take RMDs from different types of accounts. If you have multiple IRAs, you're allowed to take your combined total RMD for the combined IRA fair market value portion from just one of your IRA accounts, however, you must take your RMD from a qualified retirement plan (401(k), Cash Balance, etc.) separately from each account.
After saving for retirement most of your life, the time will come that you will need to begin withdrawing this money. For RMDs, the process may seem confusing the first time around, but the team at RPCSI can help guide you through the process. If you're ready to begin saving for retirement or planning your RMDs, give us a call today!
