Beginning April 1 of the year after you turn 70½, and every year thereafter, IRS rules require you to begin taking required minimum distributions (RMDs) from all of your qualified accounts, including employer 401(k) and 403(b) accounts as well as any traditional IRAs. If you fail to take the proper RMDs, you will be subject to IRS fines and penalties of up to 50 percent of the amount you should have withdrawn.
Want to figure out how much to take and from which accounts to take it? To determine your RMDs, you will need to reference the IRS Uniform Lifetime Table, which determines a life expectancy factor based on your current age. For example, in 2018, someone who is age 70 is assigned a life expectancy factor of 27.4 years. If that individual has a total of $500,000 in IRA assets, they would need to withdraw $18,248 ($500,000/27.4) to satisfy their RMD requirements. Since both your account balance and your life expectancy factor will change each year, your RMD amount will also change.
If you have multiple employer-sponsored 401(k) plan accounts, the IRS typically requires you to calculate and withdraw separate RMDs from each account. Although it’s important to note that you’re not required to take distributions from an employer-sponsored retirement plan (even if you’re age 70½ or older) as long as you are still employed by the firm. For all of your traditional, rollover, SIMPLE and SEP IRAs, however, you are allowed to add up the individual RMD amounts and withdraw the total from whichever of those accounts you prefer.
What happens if you forget or make a mistake?
Clearly, calculating annual RMDs can be complex, and as previously mentioned, mistakes can be exceedingly costly and deadlines confusing. Therefore, it’s important to seek out the assistance of your advisor to calculate your various annual RMDs as well as to strategize an optimal withdrawal strategy. Case in point: Perhaps due to market gains, your overall asset allocation has shifted too heavily towards equities. If you have two IRAs—one holding mostly stocks and the other holding mostly fixed income—it may be more beneficial to sell stocks and take your RMDs from the first IRA to help rebalance your portfolio.
The benefits of advance planning for RMDs can’t be overstated. If you are in your late 50s or 60s, now’s the time to begin planning how to minimize your taxes when you’re in your 70s. Not only can substantial RMDs push you into a higher tax bracket, they potentially can render up to 85 percent of your annual Social Security benefit subject to federal income taxes.
In some cases, it may be advisable to take small, penalty-free annual distributions when you are in your 60s (before RMDs kick in). Alternatively, you may want to consider converting a portion of your traditional IRA into a Roth IRA each year. Although you will have to pay income taxes on any amount converted, it may be at a lower tax rate if you're already retired and not yet taking RMDs. Roth IRAs offer continued tax-deferred growth with no RMDs, and provide qualified tax-free future withdrawals or a tax-free inheritance for your heirs if you never need the assets.
What if you don’t need the income from RMDs?
For the most part, RMDs are an inevitable payback to the IRS for the privilege of years of tax-deferred growth. However, if you’re fortunate enough to not need the income from RMDs to fund your retirement, there are other ways to put those assets to work.
If the rising cost of healthcare worries you, you may want to consider using annual RMDs to build an emergency fund to cover any unexpected future healthcare costs, or use them to pay the premiums on a long-term care insurance policy.
If you’re looking to maximize the legacy you leave for your heirs, RMDs could be used to fund the annual premiums on a life insurance policy held in an irrevocable life insurance trust (ILIT). The death benefit associated with the insurance policy will typically be much larger than years of accumulating your RMDs in low-risk investment vehicles, and your beneficiaries won’t have to pay taxes on any of the insurance proceeds they receive.
If making a philanthropic impact is important to you, the newly enacted Tax Cuts and Jobs Act offers added incentives to make tax-free transfers of RMDs directly from your IRA to any 501(c)(3) registered charity.
Of course, pursuing any of these strategies will still necessitate paying taxes on your RMDs. Determining whether or not a particular strategy aligns with your financial plan, however, requires a thorough planning discussion with your advisor. You may also want to consider consolidating your retirement accounts to help ensure that your advisor has a complete and accurate view of your entire retirement picture.
This is why you’ll want to sit down with your advisor to develop a thoughtful strategy that will not only endure, but be flexible enough to adapt as your needs and circumstances evolve. By working together and using our collaborative SunTrust SummitView® planning approach, you’ll be able to craft a financial planning and retirement solution that addresses your needs today, and for years to come.