Withdrawal Strategies: IRAs, 401ks, and Required Minimum DistributionsSubmitted by Mission Financial Planning on August 23rd, 2013
It is important to have an understanding of how Required Minimum Distributions, often referred to as “RMDs”, fit into your overall financial plan. This blog post will cover the basics, but it always makes sense to consult with a financial planner or CPA for personalized advice.
The principle behind RMDs is simple: once you reach the age of 70.5, you are required by the federal government to withdraw a certain amount of money from your IRAs or 401(k)s every year.
How much you must withdraw depends on a number of factors. The minimum is always based on a life expectancy number. Explained simply, you divide your IRA balance by your statistical life expectancy. The result is your RMD for that year. Take less than the minimum and you can be subjected to heavy fines. In fact, the IRS will fine you 50% of the amount not withdrawn if you miss – or underestimate – a withdrawal.
Why the hefty fine? The contributions weren’t taxed going in and have grown tax deferred, all for the purpose of incentivizing saving for retirement. At age 70.5 it’s time to “pay the piper” through the income taxes that are levied on the withdrawals.
If you’re not sure how much to withdraw, you’ll need to make some calculations. The simplest way to estimate your RMD is to use an online RMD calculator. Simply enter the balance of your account at the end of the previous year, as well as your age, and you’ll get the minimum withdrawal amount. For example, if you have a previous year-end account balance of $100,000 and you’re 71, your RMD is $3,773.58. This number is based on life expectancy and account balances, so amounts change from year to year. A different life expectancy chart can be used when spouses’ ages are more than 10 years apart, or if the IRA is one you have inherited.
If you’ve reached the age of 70.5 and are still working, you can sometimes delay withdrawals, such as RMDs connected to employer-sponsored retirement plans. However, special restrictions apply to business owners (generally, dental practice owners over the age of 70.5 would be required to take Required Minimum Distributions from their 401k).
Many more rules apply to RMDs regarding timing, aggregating IRAs, charitable contributions from IRAs and beneficiary IRAs. If you want to truly understand how RMDs work, you can read IRS Publication 590, Individual Retirement Arrangements (IRAs), or talk in more detail with Mission Financial Planning.