What you need to know
When you reach age 70½, the Internal Revenue Service instructs you to start making withdrawals from your traditional IRA(s). These withdrawals are also called Required Minimum Distributions (RMDs). You will make them annually from now on.
If you fail to take your annual RMD or take out less than the required amount, the I.R.S. will notice. You will not only owe income taxes on the amount not withdrawn; you will owe 50% more. (The 50% penalty can be waived if you can show the I.R.S. that the shortfall resulted from a “reasonable error” instead of negligence.)
Many IRA owners have questions about the rules related to their initial RMDs, so let’s answer a few.
How does the I.R.S. define age 70½?
Its definition is pretty straightforward. If your 70th birthday occurs in the first half of a year, you turn 70½ within that calendar year. If your 70th birthday occurs in the second half of a year, you turn 70½ during the subsequent calendar year.
Your initial RMD has to be taken by April 1 of the year after you turn 70½. All the RMDs you take in subsequent years must be taken by Dec. 31 of each year.
So, if you turned 70 during the first six months of 2020, then you will be 70½ by the end of 2020, and you must take your first RMD by April 1, 2021. If you turn 70 in the second half of 2020, then you will be 70½ in 2021, and you won’t need to take that initial RMD until April 1, 2022.
Is waiting until April 1 of the following year to take my first RMD a bad idea?
The I.R.S. allows you three extra months to take your first RMD, but it isn’t necessarily doing you a favor. Your initial RMD is taxable in the year that it is taken. If you postpone it into the following year, then the taxable portions of both your first RMD and your second RMD must be reported as income on your federal tax return for that following year.
How do I calculate my first RMD?
I.R.S. Publication 590 is your resource. You calculate it using I.R.S. life expectancy tables and your IRA balance on Dec. 31 of the previous year. For that matter, if you Google “how to calculate your RMD,” you will see links to RMD worksheets at irs.gov and a host of other free online RMD calculators.
If your spouse is more than 10 years younger than you and happens to be designated as the sole beneficiary for one or more of the traditional IRAs that you own, you should use the I.R.S. IRA Minimum Distribution Worksheet (downloadable as a PDF online) to help calculate your RMD.
If your IRA is held at one of the big investment firms, that firm may calculate your RMD for you and offer to route the amount into another account of your choice. It will give you and the I.R.S. a 1099-R form recording the income distribution and the amount of the distribution that is taxable.
When I take my RMD, do I have to withdraw the whole amount?
No. You can also take it in smaller, successive withdrawals. Your IRA custodian may be able to schedule them for you.
What if I have more than one traditional IRA?
You figure your total RMD by calculating the RMD for each traditional IRA you own, using the IRA balances on the prior Dec. 31. This total is the basis for the RMD calculation. You can take your RMD from a single traditional IRA or multiple traditional IRAs.
What if I have a Roth IRA?
If you are the original owner of that Roth IRA, you don’t have to take any RMDs. Only inherited Roth IRAs require RMDs.
Be proactive when it comes to your first RMD. Putting off the initial RMD until the first quarter of next year could mean higher-than-normal income taxes for the year ahead.
Dave B. Rao is the founder of RAO Wealth Partners. He focuses his practice on helping to advise physicians, corporate executives and business owners on their unique financial situations. For more info, visit raowp.com. Our firm does not render legal or tax advice. This article was written for our firm and provided courtesy of MarketingPro.
Investments in securities and insurance products are NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE. Rao Wealth Partners is an independent firm with securities offered through Cetera Advisor Networks LLC., member FINRA and SIPC. Advisory services are offered through Summit Financial Group, Inc., a registered investment adviser. Summit and its affiliates are under separate ownership from any other named entity.