Your Favorite Uncle Wants His Share of the Pie

Do you have that one uncle at Thanksgiving that, as congenial as he may be at other times, grows very serious when it comes to slicing up the apple pie?  Well, Uncle Sam is the same way.  When it comes to collecting tax on your retirement plan savings, he wants his share. 

In general, individuals tend to concentrate their savings in retirement plans–using employer-sponsored plans such as 401(k)s and 403(b)s or using IRAs–because the tax code incentivizes us to do so.  We can save tax today by making pre-tax or tax-deductible contributions to these accounts, and the funds can grow tax-deferred for years, even decades, until we withdraw them in retirement. 

However, Uncle Sam will not let us avoid taxes on these funds forever.  Whether we need to use the funds or not, the U.S. government requires that we begin to make withdrawals (otherwise known as required minimum distributions, or RMDs) starting at age 70 ½.  If an individual does not withdraw (and pay taxes on) the required amount, he or she will face an additional tax of 50% on the amount not withdrawn on his or her federal tax return.

Do I Have To?  Yes.  One possible exception is that if you are still working at age 70 ½, you may not have to take RMDs from the retirement plan for your current employer, but even that is contingent upon permission from the employer plan.  And if the account is an IRA, or you are a 5% owner of the business sponsoring the retirement plan, you have to start taking RMDs at age 70 ½, whether you are retired or not.

Which Plans?  RMD rules apply to employer-sponsored plans such as 401(k)s, 403(b)s, 457(b)s, and profit sharing plans, as well as IRAs, SEP IRAs, SIMPLE IRAs and SARSEPs.  RMDs are currently not required for Roth IRAs (until after the account owner passes away), though Congress could certainly change this rule in the future. 

When?  Your first RMD must be withdrawn by April 1^st of the calendar year after the year in which you turn 70 ½.  All subsequent RMDs must be withdrawn by December 31^st of the relevant calendar year.  Despite the extension of time for taking your first RMD, we generally recommend that clients take their first RMDs by year end as well in order to avoid taking two RMDs in the calendar year after turning 70 ½, which could potentially drive them into a higher tax bracket. 

How Much?  The RMD amount is determined by dividing the amount in your retirement plans at the end of the previous year by a life expectancy factor. The chart to the right gives details and an example of this.

Can I Withdraw More Than the RMD Each Year?  Yes, just be sure to consult your wise financial advisor to ensure that you are withdrawing an amount that is sustainable for your lifetime.

Do the Same Rules Apply to Inherited Retirement Accounts?  Yes, and no.  In certain cases, when a retirement account owner has died before beginning to take RMDs, beneficiaries may be required to withdraw the entire amount of the inherited account within 5 years following the account owner’s death.  However, most beneficiaries have the option of stretching out the withdrawals over their lifetimes and choose to do so, in the interest of taking advantage of the account’s tax-deferred status.  In this case, they are subject to RMDs, but the RMDs are calculated differently for beneficiaries than for account owners, depending on whether or not the beneficiary was a spouse of the deceased, whether or not the owner died before RMDs began, etc.

Similar to your uncle at Thanksgiving, neglecting to give Uncle Sam his share of the pie may have significant repercussions, so be sure to know and play by the rules.  As always, we are here to help!