Required Minimum Distributions
Today we discuss required minimum distributions and cover:
- when you have to start taking them
- why it’s important to take them
- the basics of how they’re computed
- when during the year is the best time to take your distribution
- and, what you can do with the money if you don’t need the income
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Required Minimum Distributions
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Required minimum distributions may not be an interesting topic, but our clients ask a lot of questions about them. If you’re heading towards your retirement, it’s something that should be on your radar.
When do you have to start taking your required minimum distributions?
In 2019, the government passed the SECURE Act. This legislation increased the age at which you have to start your required minimum distributions. It used to be the year you reached age 70½. Now, you must start the year you reach age 72.
Why do you want to take your required minimum distributions?
If you don’t take your RMD, the penalty is severe. The penalty is 50% of the shortfall. If your required amount is $10,000 and you fail to take that, the IRS penalty is $5,000.
How much do you take the first year?
Your first RMD is roughly 4%. The IRS uses the Uniform Lifetime Table. It is a life expectancy table which uses a 10-year difference in age between spouses. If your spouse is more than 10 years younger than you, you can do things differently.
You look up your age on the table find the divisor. The first year the divisor is 25.6. (25 equates to 4%.) The next year, the divisor goes down a little bit, which means the percentage increases.
Here is an example. The balance of your IRA at year’s end is $256,000. Divide that by 25.6. The amount you have to withdraw is $10,000. Next year, you divide the year-end balance by 24.7. The following year, you divide the year-end balance by 23.8. You always take the balance at the end of each year and divide it by the number for your age.
Eventually, you will take more from the account than you can earn. At age 88, the amount is about 8%. At age 92, the required amount is roughly 10%.
When is the right time to take your distribution?
Some clients take their RMD early in the year. Others wait until later in the year. Many people worry about what is happening in the investment markets. If the stock market is near all-time highs, a lot of people will want to take it at that point.
We do not know what will happen later in the year. Values could be higher or lower than they are right now. The correct answer to this question is, “take the distribution when you need the money.”
Most custodians will withhold taxes from your IRA distribution. Most will withhold both state and federal income taxes. If you pay quarterly estimates, you should adjust your estimated tax payment.
What if you don't need the money?
One of the better planning tools you can use is a qualified charitable distribution. You direct a distribution from your IRA directly to a charity of your choice. You do not report the distribution as income. You will save both the state and federal income taxes on the amount that you donate.
The other thing you can do is reinvest your distribution in a taxable account. Many custodians allow you to transfer shares of an investment to another account. This is an “in kind” transfer. You can also transfer cash.
You cannot convert your required minimum distribution to a Roth IRA.
Benefits of Using a Roth IRA
There are no required minimum distributions from Roth IRAs. It’s another great reason to use the Roth IRA to help you save for your retirement.
These specific rules only apply to the original account owner or their spouse. If you have an inherited IRA, different rules apply to you.
Talk to a Certified Financial Planner™ Professional
If you have specific questions about your situation, a financial planner can help. Talk to one today. Click below to schedule a call
About the Author
Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors. He specializes in helping hard working, middle class families plan for retirement.