RMDs: Required Minimum Distributions or Required Maximum Deficits?

We all love receiving deductions on our tax returns, but an even better feeling is when we can delay the tax bill to the IRS from our paychecks. We do this by contributing to retirement plans, where we receive a reduction in our taxable income during the year we contribute.

However, we need to go back to the word delay. Notice we did not say remove.

So what happens when delay becomes now? The IRS will get their taxes due on the money you delayed previously through something call Required Minimum Distributions (RMDs).

Definition of Required Minimum Distribution per the IRS: Your required minimum distribution is the minimum amount you must withdraw from your account each year.

Nothing about RMDs is fun, but the sake of documentation, here are some fun facts about RMDs:

• Due to changes made by the SECURE Act, if your 70th birthday is July 1, 2019 or later, you do not have to take withdrawals until you reach age 72. Roth IRAs do not require withdrawals until after the death of the owner.
• You can withdraw more than the minimum required amount.
• Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).

The minimum distribution rules apply to the following accounts:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k) plans
• 403(b) plans
• 457(b) plans
• profit sharing plans
• other defined contribution plans

Notice Roth IRAs and Roth 401(k)s are not included in the above list!

My goal is to help you understand two vastly important items regarding RMDs in this article:

1)    Planning to limit RMDs

2)    Timing and Calculation of RMDs

3)    Consequences of not taking RMDs

Planning to Limit RMDs

Many individuals begin to ask the question about how to handle RMDs either when they are due or about a year before they are due. They usually consult their CPA or an investment professional on how to optimize RMDs. Tough news you need to hear – this is too late.

The best time to begin optimizing RMDs is around age 55 – roughly 17 years before they are required to begin. This statement should raise an eyebrow, or two.

Why age 55? This is not a hard and fast number, but rather a good starting point to begin to analyze when and how much to do in annual Roth Conversions.

I wrote a previous article titled, “Roth Conversions: Choose When To Pay Your Taxes.” This is exactly why you begin to manage your RMDs early and often in your financial life. I strongly urge you to read that article, it will give you details on why Roth Conversions are beautiful.

A Roth Conversion converts your tax-delayed financial capital money into a Roth IRA, which grows tax free. Roth IRAs are incredible, the owner of the account never pays taxes on any of the funds, including contributions, conversions, and future investment growth.

By converting tax delayed money to a tax-free Roth IRA account, income taxes due must be paid on the converted funds in the year of conversion. Here is the benefit of a Roth IRA per the IRS website:

A Roth IRA is an IRA that, except as explained below, is subject to the rules that apply to a traditional IRA.

• You cannot deduct contributions to a Roth IRA.
• If you satisfy the requirements, qualified distributions are tax-free.
• You can make contributions to your Roth IRA after you reach age 70 ½.
• You can leave amounts in your Roth IRA as long as you live.

Guess what – no RMDs are required in a Roth IRA. If you convert your tax delayed money into a Roth IRA, little by little, year over year, you then choose when to pay your taxes, optimize your taxes, and eliminate the need for RMDs.

Financial flexibility at its finest.

Timing and Calculation of RMDs

In the event you do not execute step 1 above fully, or have some tax delayed money that you could not convert, here is general information regarding RMDs:

Timing:

Deadline for receiving required minimum distribution:

· Year you turn age 72 - by April 1 of the following year

· All subsequent years - by December 31 of that year

Calculation:

IRS Language: The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.”

Human Translation: Your calculation of your RMDs first begins with taking the account balance of your retirement account(s) as of the end of the previous year divided by a number that the IRS determines for you.

The IRS provides nice worksheets to calculate the required amount to be distributed to you. If your spouse is not more than 10 years younger than you (an IRS rule), follow these steps to determine your RMD:

1)    Retirement Account balance on December 31 of previous year

2)    Distribution period from the table below for your age on your birthday this year.

3)    Step 1 Number divided by number entered for step 2. This is your current year RMD.

4)    Repeat steps 1-3 for each retirement account (not Roth accounts)

A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner.  In this regard, the following materials will be useful to you in determining required distribution amounts and payout periods:

• tables to calculate the RMD during the participant or IRA owner’s life:
  • Uniform Lifetime Table -for all unmarried IRA owners calculating their own withdrawals, married owners whose spouses aren’t more than 10 years younger, and married owners whose spouses aren’t the sole beneficiaries of their IRAs
  • Table I (Single Life Expectancy) is used for beneficiaries who are not the spouse of the IRA owner
  • Table II (Joint Life and Last Survivor Expectancy) is used for owners whose spouses are more than 10 years younger and are the IRA’s sole beneficiaries

Again, RMDs are the government making sure they get their taxes. Rather than go through the above, I would prefer to choose when I will have to pay my taxes on my retirement funds. Go back to the Planning to Limit RMDs.

Consequences of not taking RMDs

If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. Ouch.

Plain and simple – do not miss RMDs. It is like missing mortgage payments for 6 months – eventually all your hard work of saving and investing is eliminated

Conclusion:

RMDs are not something to plan for once they are required to be distributed. That is too late.

Get with an investment professional who can optimize your taxes by converting your tax delayed accounts little by little, year over year, to fully eliminate your need for RMDs.

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