Plan Ahead To Avoid This IRA Tax Trap
If you are close to age 70, and own one or more retirement accounts, start planning ahead to manage required minimum distributions (RMD). Even when you are taking a distribution by your deadline, you could be in for a surprise by the amount you must take out to comply with RMD rules, and this could cause problems if markets and the value of your retirement accounts go down right beforehand.
While you may have tapped your retirement savings for small amounts now and then, IRS rules mandate that you take your first RMD in the year in which you turn age 70½. The first payment can be delayed until April 1 of the year following the year you turn 70½, but you must take the RMD by December 31st of every subsequent year thereafter. Failure to withdraw the full amount of the RMD, or failing to withdraw it by the applicable deadline, can result in a tax penalty of 50% of the RMD amount that was not withdrawn.
Often, retirees approaching age 70½ put off the distribution as long as possible allowing funds to continue to grow. That strategy can backfire, because it only works when the market is steadily going up. If the market goes down right when you need to take a distribution from your account, you may be forced to sell depreciated assets when the stock market is down.
This is exactly what happened to retirees last year when stocks plunged in December. The surprise came because the amount of the minimum withdrawal in 2018 was determined on the account balance on December 31st of the prior year —2017, when the stock market was up.
Thus, to reduce your risk you may want to take your first RMD earlier and put it into your checking or savings account, or design your portfolio to ensure the required amount of cash will be on hand prior to the deadline.
RMD rules affect all employer-sponsored retirement accounts, including 401(k) plans, traditional IRAs and IRA based plans such as SEPs and SIMPLE IRAs. The rules also apply to Roth 401(k) accounts, but DO NOT apply to Roth IRAs while the owner is alive.
Although your IRA plan custodian or administrator may help you calculate your RMD, in the eyes of the IRS, you are the one responsible for calculating the amount of the RMD from all the plans that you own (that are affected by the rules). TSCL strongly recommends calling your plan administrator to discuss a plan to ensure your RMD cash will be available when you need it, should markets dip.
Resources: To calculate a Required Minimum Distribution (RMD) you can find an IRS worksheet here: https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf
Source: “Here’s the Trickiest IRA Tax Trap Retirees Need to Avoid,” Steve Vernon, CBS News, February 4, 2019.