Watch Out Baby Boomers it’s Time to Begin Taking Your RMD

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It is estimated that over the next 18 years about 10,000 people a day will turn 70½. This will create a potential windfall for the Treasury Department, because these distributions are taxable at the highest marginal income tax rate.

Why are people being forced to take distributions?
IRAs and other retirement plans were not designed to allow people to transfer wealth or leave an inheritance. They were created to provide income during an individual’s retirement years.

The initial wave of Baby Boomers who were born in the first half of 1946 must begin taking their required minimum distributions (RMD) as of July 1, which are distributions from their retirement accounts held in IRAs, 401(k)s and similar plans. That’s because those born in January 1946 become 70½ in July of this year, and the distribution rules specify the latest the distributions may begin, without penalty, is April 1 in the year after turning 70½. Moving forward, annual distributions must be taken by December 31 each year in order to avoid a 50% penalty on the amount they failed to withdraw.

What happens if you wait until April to take the first distribution?
While April 1, 2017 is the latest time to begin distributions for those turning 70½ this July, it is usually advisable to take the initial distribution no later than December 31. If one waits until next April, then both the 2016 and 2017 distributions must be taken in 2017 and that may cause some additional income tax and other costs for the taxpayer.

That may not sound like a big deal, but one of the repercussions of taking two distributions in the same year is that it may increase Medicare premiums related to the higher reported income. Those higher premiums are then locked in for the next year.

Missing the April 1 deadline or not taking out the full distribution amount required can also be costly. There is a 50% excise tax on any amount that one fails to withdraw. For example, if you were required to take out $1,000 and you failed to meet the deadline, it’s a $500 excise tax penalty. That also means that the $1,000 is added to your ordinary income on which you are taxed. If that tax rate is 15%, then that means you will need to pay an extra $150 in income tax. So you could end up paying an extra $650 in taxes because you missed taking the $1,000 distribution on time.

Do I have to take the distribution from a specific IRA?
You can take your distribution from any one of/or combination of your qualified retirement accounts, as long as you take out the entire amount required for that tax year.  For example, Fred has 5 IRAs and the total value is $250,000. His RMD on those accounts would be approximately $8,000. Fred can elect to have that $8,000 come out of just one of his IRAs or he can spread it out across any combination the five different IRAs, however he chooses, as long as he meets the full amount of the RMD.

What if I am still working?
“If you are still working at 70½, you don’t have to take a distribution from your current employer’s 401(k) plan until you leave your job. Although you cannot contribute to a traditional IRA once you turn 70½, you can continue funding a 401(k) plan if you keep working beyond that age (unless you own 5% or more of the company). However, once you stop working, you must begin your annual required minimum distributions and can no longer fund your employer-based retirement plan,” says Mary Beth Franklin, contributing editor to InvestmentNews.

“If you have multiple 401(k) plans, you must calculate a separate required minimum distribution from each employer plan and you must take a distribution from each plan each year once you turn 70½.”

Donations
The most recent tax law changes preserved the option for IRA owners who are at least 70½ to donate up to $100,000 per person to charity and avoid the taxes on the amount donated.

For married couples, each spouse can give up to $100,000 per person of their RMD directly to charity, with the exception of private foundations and donor-advised funds, which are not eligible. Any money that is donated will be excluded from taxable income, although it will no longer qualify for a charitable deduction.

One-Time Transfers to an HSA
“You may be able to make a qualified funding distribution from your traditional IRA or Roth IRA to your health savings account (HSA). The one-time distribution must be less than or equal to your maximum annual HSA contribution, and it must be made directly by the trustee of the IRA to the trustee of the HSA,” notes Franklin. “The distribution is not included in your income, but it cannot be deducted as an HSA contribution.”

If you are nearing 70½ and have questions regarding how to calculate your RMD, when to begin taking it or how you might be able to reduce your tax burden, why not schedule a time to sit down and review your specific situation.