If you possess a retirement account and are approaching the age of 70, you must ensure compliance with specific IRS regulations. The IRS mandates that individuals commence making Required Minimum Distributions (RMDs) at the age of 70 and a half. Failing to do so incurs a substantial penalty of 50% for non-compliance.
This article will delve into the intricacies of avoiding RMD penalties on your retirement account distributions. If you happen to be below the age of 70 and have invested in retirement funds, keep reading, as you may find valuable information on preparing for RMDs.
Understanding RMDs
RMD, or Required Minimum Distribution, is a requirement set forth by the IRS. It stipulates that individuals who reach the age of 70 and a half must withdraw a specific amount from their tax-sheltered retirement accounts annually. The purpose of this regulation is to ensure that the federal government receives its share of tax revenue from these accounts.
Retirement accounts subject to RMDs encompass various types, including Traditional IRAs, Rollover IRAs, Inherited IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, 457(b)s, and Keogh Plans. An exception to note is that Roth IRAs are not subject to RMDs. However, this exception does not apply to inherited Roth 401(k)s.
When Must You Take RMDs?
The initial RMD is due no later than April 1 of the year following the year in which you turn 70 and a half. For instance, if you reach this milestone between January 1 and June 30 in 2021, your deadline is April 1, 2021. If your 70th birthday falls between July 1 and December 31, 2021, the deadline is April 1, 2022. Subsequent RMDs must be taken by December 31 of each succeeding year.
An exception exists for individuals who are 70 or older, still working, and own 5% or less of the company they work for. They can delay their RMD from a 401(k) until retirement.
It’s essential not to wait until April 1 of the year after turning 70 and a half, as this would necessitate two distributions in the same year, potentially pushing you into a higher tax bracket and increasing your tax liability.
Calculating Your RMD
RMD calculations involve determining the amount of money in your retirement account and relating it to the IRS’s life expectancy estimates. You divide the total of your RMD-eligible accounts by the distribution period established by the IRS. The IRS Uniform Lifetime Table provides guidance for these calculations.
As an example, if you have $100,000 in a traditional IRA and are 70 years old, your life expectancy is approximately 27.4 years. Therefore, your RMD would be approximately $3,650, as calculated by dividing your total retirement account balance by 27.4. If you were 80 years old, your RMD would increase to $5,350, corresponding to an expected remaining lifespan of 18.7 years.
Exceptions apply when your spouse is more than 10 years younger and the sole beneficiary, allowing the use of the IRS’s “joint life expectancy” method to reduce the RMD amount.
Taxes and Penalties
RMDs are subject to taxation as ordinary income at your federal income tax rate, and you may also owe state taxes on the distributed funds. To prevent a substantial RMD-related tax bill, consider withdrawing funds earlier if they are poised to push you into a higher tax bracket.
Conversely, converting traditional IRAs to Roth IRAs during low-earning years can help control your tax bracket during retirement, as Roth IRAs are exempt from RMDs.
Failure to withdraw the required RMD can result in a 50% penalty. For instance, if you should withdraw $15,000 but fail to do so, you could be penalized $7,500. However, the IRS may grant a penalty waiver for a reasonable excuse, particularly for first-time offenses.
In summary, it is imperative to prepare for RMDs once you reach the age of 70 and a half. Neglecting to do so can lead to significant penalties, emphasizing the importance of compliance with IRS regulations.
