Required Minimum Distributions

Credit: Stuart Miles

In my line of work, I get to surprise people all of the time. Sometimes my advice or the conclusion of my financial analysis evokes an elated and relieved response. Sometimes it does not, but instead confirms a painful reality or brings about sadness and temporary distress (not to worry: I’m happy to develop a new plan or strategy for my clients who find themselves in temporary distress).

One of the most frequent surprises I get to deliver is the news that in the year you become 70 ½ years of age, if you have certain retirement investment accounts like a 401(k), Traditional IRA, or qualified (tax-deferred) annuity, you are required to start taking minimum distributions, whether you want to or not! Technically, you could choose not to take your minimum distributions and agree to pay one of the most onerous IRS penalties of 50% of the amount you should have withdrawn, but since I’ve never had any takers on that strategy, let’s push forward assuming you will take your required minimum distributions (RMDs).

The amount that has to be distributed is based on IRS life expectancy tables and the age of your spouse (or designated beneficiary). It’s a relatively simple multiplication problem consisting of your account’s previous year-end value and your applicable life expectancy factor, but there are so many tables and beneficiary circumstances to consider that I’d suggest you let your financial advisor or CPA do it for you. There are some brokerage firms and custodians that will actually calculate your RMD for you on your brokerage statements when they become required, but please note that brokerage firm calculations will only be relative to the accounts you have with them. If you have multiple accounts that require RMDs, you’ll need to be careful, and make sure you take enough in total and from each account to avoid the before-mentioned “bear” of a tax penalty.

This required distribution can be a good surprise. If you’re not already withdrawing from your retirement account, this distribution can feel like a little extra income that could be used for anything from family trips to home renovations. I should mention, though, that your distribution does not have to be spent! You have to withdraw it and you have to pay taxes on your withdrawal, but you’re welcome to top off your savings account or reinvest the proceeds in your after-tax brokerage account.

This required distribution can be a bad surprise if you didn’t know you had to do it (or forget to do it), but even if you’re on top of things, it still stinks because the tax man cometh. Uncle Sam wants to wish you a happy birthday from age 70 ½ on, and to commemorate the occasion, he’s going to want ordinary income taxes from your distribution amount to help fill his empty coffers.

If you’ve read this post, there is no reason to let RMDs surprise you. If you are 70 ½ or older, please double check with your financial advisor and CPA to make sure you are taking your RMDs. If you’re almost 70 ½, I’d urge you to meet with your financial advisor and make sure you have a game plan in place for your RMDs as there is often an opportunity for meaningful and significant tax and cash flow planning. If you’re nowhere near 70 ½, I bet you can think of someone you care about who is and would appreciate you looking out for them.

-Tom