Happy holidays from Cooperative Extension and best wishes for financial success during 2012. During the past year, we published over 300 eXtension frequently asked questions (FAQs) on various financial topics. eXtension is the online Cooperative Extension information delivery system which you are visiting at this time.
We receive hundreds of “Ask an Expert” questions from consumers annually to which we respond via e-mail. We then turn many of them into FAQs. The most frequent topic of eXtension personal finance questions from consumers in 2011 was required minimum distributions (RMDs) from tax-deferred retirement savings plans such as traditional IRAs and 401(k)s. This topic is confusing for many people. After all, who counts half-year birthdays unless you’re trying to get a child born late in the year into kindergarten or you’re calculating RMDs? RMDs were especially confusing in 2010 and 2011 due to the postponement of the RMD requirement in 2009 as a result of legislation following the financial crisis.
With the December 31 deadline for 2011 RMDs looming, this article will review the basics of RMD withdrawals. If you are age 70 ½ or above, getting close to that age, or a caregiver or custodian for an older person, read on to learn what you need to know. If you are none of the above, continue saving for retirement and know that you’ll need to make RMD withdrawals on your tax-deferred savings plans at some future date.
- There are two “crunch” dates for RMDs: December 31 (the deadline for routine annual RMD withdrawals after age 70 ½) and April 1 (the deadline for legally postponed RMD withdrawals).
- Owners of tax-deferred accounts can start taking withdrawals from retirement plans as early as age 59½ but must begin RMDs upon reaching age 70 ½. Some people need the money early in retirement and will elect to take penalty-free withdrawals as soon as they are able. If possible, though, financial advisors recommend waiting to tap tax-deferred retirement savings accounts until RMDs are required. This enables you to earn an extra decade of compound interest on your retirement savings free of taxes, which has the effect of stretching out your assets and making them last longer.
- Roth IRAs do not have a RMD requirement. Minimum payments from regular IRAs must begin by April 1 of the year following the year when an account owner turns 70 ½. For example, if someone turned 70 between January and June, 2011, they would turn 70 ½ between July and December, 2011. This means that they have until April 1, 2012 to make their first RMD withdrawal.
- The downside to postponing the first RMD withdrawal to April 1 of the following year is the necessity to take two RMD withdrawals (the previous year’s withdrawal and the current year’s withdrawal) that year, which could increase your marginal tax bracket. After the first year, RMDs must be made by December 31 of each year, which explains the flurry of AaE questions that eXtension receives this time of year.
- RMDs from qualified retirement savings plans such as 401(k)s are also due when someone turns 70 ½ or the year than an employee actually retires. The latter rule applies only to an older worker’s current employer’s plan and not to IRAs or tax-deferred savings plans sponsored by previous employers.
- To calculate your RMD, you take the balance in your retirement account on December 31 of the previous year and divide it by the appropriate divisor for your age. IRS tables provide the correct divisor to use. You can always withdraw more than the RMD amount but, of course, the money is taxed as ordinary income along with your other income for the year.
- It is very important to get the RMD calculation correct. If not, the IRS charges a penalty equal to half the amount that you should have taken out but didn’t. For example, if your correct RMD amount is $10,000 and you only withdraw $5,000, you’ll owe a tax penalty of $2,500 (half of $5,000).
- People have asked eXtension what they should do with their RMD withdrawal. Many are so used to saving that spending the money seems like a foreign concept. The answer is that you can do whatever you want. Options include living expenses, savings in a taxable account, savings in a Roth IRA (if you have earned income at any age and meet the income limit), gifts to family and/or charities, and fun.
- You can combine multiple IRA accounts or multiple 403(b) accounts and take a distribution for all of them from one or any combination of accounts. You cannot, however, combine withdrawals for IRAs with other types of accounts, such as 403(b)s or 401(k)s, nor can you combine personal and inherited IRAs. Withdrawals from multiple 401(k) plans must also be taken separately and cannot be combined.
