Seventy-two is an important age milestone for those in or near retirement, as it marks the time when required minimum distributions (RMDs) begin to be withdrawn annually from IRAs and employer-sponsored retirement plans (previously, the threshold was 70 ½). The milestone carries with it tax consequences that aren’t fixed. Rather, there are a few rules to consider that can help you optimize the impact on your bottom line.
IRAs
You must begin withdrawing from a traditional IRA (Individual Retirement Account) by April 1 following the year in which you turn 72. The amount is based on your age with one exception: if you’re married and your spouse is more than 10 years younger than you, the RMD amount is based on your joint life expectancy. If your distribution is less than the required minimum, you’ll be penalized 50% of the difference.
NOTE: Roth IRAs don’t require an RMD.
Employer-sponsored retirement plans
For employer retirement plans – 401(k)s, 403(b)s, and others – the same timeline applies as per IRAs: you must begin withdrawing from the plan by April 1 following the year in which you turn 72. However, if you’re still working past 72 and you own 5% or less of a company, you may be able to delay RMDs until you retire.
Additionally, depending on your circumstances, you may receive a lump-sum distribution from 401(k), profit-sharing, and stock purchase plans if completed in a one-year period. If you meet the terms of this lump-sum distribution, you’ll be taxed at the rate for single taxpayers established in 1986. Additionally, if you’re born before 1937, you qualify for a 10-year forward income averaging. For tax purposes, RMDs from qualified retirement accounts are taxed as ordinary income.
Calculating your distribution
The institution where your retirement is kept typically determines the RMD amount using the formula:
Total balance as of December 31 divided by Your life expectancy = Distribution amount
However, there is some leeway that may provide you with more beneficial tax consequences:
| 1 | RMD timing | You can either take your initial RMD in the year when you turn 72 or up until April 1 of the following year. |
| 2 | Delaying RMD | If you delay your RMD until the following year, you must take two RMDs that year which may increase your tax consequences. |
| 3 | Series of withdrawals | You can take your RMD as a series of withdrawals rather than one lump payment, which may help you with monthly cash flow. |
| 4 | Update your beneficiaries | Update your beneficiary(ies) as to your distributions. For IRAs, account holders can designate anyone as a beneficiary; For employer-sponsored plans, they must designate their spouse as a beneficiary unless the spouse specifically waives the right. |
Seek help
Tax consequences for RMDs can be significant and seeking the support of a financial professional can be prudent, to ensure the results align with your goals.
SCE FCU Wealth Management