“Time flies” was a recent quote that I had from a client. Remember a long time ago…putting money aside in your retirement accounts, perhaps at work in a qualified traditional 401(k) or to an individual retirement account (IRA)? It’s easy to ‘forget’ about it because, it was after all, meant to be used many years down the road. It would be nice to keep your retirement funds indefinitely; unfortunately, that can’t happen, as the government wants to eventually collect the tax revenue from years of tax deferred contributions and growth.
In general, once you reach the age of 70 ½, per the IRS, many of those qualified accounts are subject to a Required Minimum Distribution (RMD) and you must begin withdrawing that minimum amount of money by April 1 of the year following the year that you turn 70 1/2. Of course, there are a few exceptions with regards to qualified accounts, but as a rule, when you reach 70 ½, you must begin taking money from those accounts per IRS guidelines if you hold a traditional 401(k), profit sharing, 403(b) or other defined contribution plan, traditional IRA, Simple IRA, SEP IRA or Inherited IRA. (Roth IRA withdrawals are deferred until the death of the owner and his or her spouse). Inherited IRAs are more complicated and handled with a few options available to the beneficiary, either by taking lifetime distributions or over a 5 year period. The importance here, is to be aware that a distribution is needed. Another word of caution…In some cases, your defined contribution plan may or may not allow you to wait until the year you retire before taking the first distribution, so a review of the terms of the plan is necessary. In contrast, if you are more than a 5% owner of the business sponsoring the plan, you are not exempt from delaying the first distribution; you must take the withdrawal beginning at age 70 1/2, regardless if you are still working.
The formula for determining the amount that must be taken is calculated using several factors. Basically, your age and account value determine the amount you must withdraw. As such, the December 31 prior year value of the account must be known and, second, the IRS Tables in Publication 590-B, which provides a life expectancy factor for either single life expectancy or joint life and last survivor expectancy, needs to be referenced. The Uniform Lifetime expectancy table would be referenced for unmarried owners and the Joint Life and Last Survivor expectancy table would be used for owners who have spouses that are more than 10 years younger and are sole beneficiaries. It comes down to a simple equation: The account value as of December 31 of the prior year is divided by your life expectancy. For most individuals, the first RMD amount will be roughly 4% of the account value and will increase in percentage each year.
It all begins with the first distribution, which will be triggered in the year in which an individual owning a qualified account turns 70 ½. For example, John Doe, who has an IRA, and has a birthdate of May 1, 1949, will turn 70 ½ this year in 2019 on November 1. A distribution will need to be made then after November 1, because he will have needed to attain the age of 70 ½ first. Therefore, the distribution can be taken after November 1 (for 2019), and up until April 1 of the following year in 2020.
Once the first distribution is withdrawn, subsequent annual RMDs need to be taken for life, and are due by December 31. In this case, John Doe will need to next take his 2020 distribution, using the same formula that determined his first distribution. This will become a regular obligation of John’s each year.
So, we’ve talked about who, what, why and when, now let’s talk about the where. Once the distribution amount is calculated, an individual can then choose where he or she would like that money to go. Depending on circumstances, if the money is not needed for living expenses, it is advised to keep the money invested within one of your other non-qualified accounts such as a trust, individual or joint account, i.e. you can elect to make an internal journal to one of your other investment accounts. Alternatively, if you have another thought for the money, you can have it moved to a personal bank account or mailed to your home. Keep in mind that these distributions are taxed as ordinary income, thus, depending on your income situation, you may wish to have federal or state taxes withheld from the distribution. At DWM, we can help our clients determine if, and what amount, to be withheld. One exception is the qualified charitable distribution or QCD, which is briefly discussed next.
Another idea that may be a possibility for some individuals is for the distribution amount to be considered a qualified charitable distribution (QCD). Instead of the money going into one of your accounts, a direct transfer of funds would be payable to a qualified charity. There are certain requirements to determine whether you can make a QCD. For starters, the charity must be a 501 (c)(3) and eligible to receive tax-deductible contributions, and, in order for a QCD to count towards your current year’s RMD, the funds must come out of your IRA by the December 31 deadline. The real beauty about this strategy is that the QCD amount is not taxed as ordinary income. You would simply provide the QCD acknowledgement receipt(s) along with your 1099R(s) to your accountant for the correct reporting on your tax return.
It may be pretty scary to know how quickly time flies, but with DWM by your side, we can take the scare out of the situation!