Sunday, June 12, 2016

RMDs: What they are, how they work and what to do

"In this world nothing can be said to be certain, except death and taxes." - Benjamin Franklin (1706-1790), among the nation's Founding Fathers, postmaster, scientist, inventor and diplomat.

Required minimum distributions:
- What: Withdrawals mandated by federal tax law from tax-deferred retirement accounts such as traditional IRAs and 401(k)s.
- Why: These are tax-deferred savings, not tax-free.
- When: At age 70 1/2.
- Impact: RMDs are taxed as ordinary income, so plan ahead.
- Withdrawal schedule: Calculated over a 27-year life expectancy beginning at 70 ½.
- Failure to make the withdrawal: The amount not withdrawn is taxed at 50 percent.


Managing RMD withdrawals:
- Use online calculators to figure when and how you take your annual required distribution. Or talk with your CPA and/or financial adviser to make sure you are on the right track.

- Review the tax impact of annual RMD income.
- Look into inheritance and beneficiary rules for IRAs and 401(k)s.
- Give IRA/401(k) money directly to charity to satisfy the annual RMD requirement.
- Make your first withdrawal before April 1 of the year you are 701/2.
- Seek professional estate planning advice to manage the RMD transition.
- Remember, the money will last longer than you might think.


BY JULIA ANDERSON
People celebrating their 70s birthdays this year -- as the vanguard of the baby boomer generation is doing – must start taking withdrawals from their tax-deferred retirement savings accounts in the next nine to 21 months, depending on when they become 70 1/2.

These annual withdrawals -- known as required minimum distributions (RMDs) -- are mandated by federal tax law. Their purpose is to let the government start collecting taxes on the savings/investments earned inside these tax-deferred accounts such as traditional IRAs and 401(k)s.

RMDs are taxed as ordinary income based on your individual tax bracket. The good news is that withdrawal rates as mandated by the IRS are relatively painless.

Here’s how it works:
You must take your first RMD for the year in which you turn age 70 ½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70 ½. All subsequent years, you can make your withdrawal by Dec. 31 of that year.

You are required to take an annual minimum distribution as determined by an IRS tax formula. The formula is based on the value of your account at year’s end.

To figure the withdrawal amount, use an IRS worksheet at www.irs.gov or an online calculator at web sites such as bankrate.com, fidelity.com or aarp.com.  The AARP calculator offers a nice graphic showing that your peak annual withdrawals will not occur until you are in your 90s. That is because withdrawals are projected over a 27-year-life expectancy to age 100. That leaves money in the account pretty much up until the end of your life.

Here are examples:
You have $200,000 in a traditional IRA and expect an average 5 percent return on the remaining tax-deferred investment going forward. At 701/2 your first annual withdrawal will be $9,549. By age 80 your annual withdrawal amount has increased to $11,848. At 90 it is up to $16,384 a year. Here’s the good news --- at age 95, even after all those annual withdrawals, your account still will have $136,000 in it, if it indeed it earns 5 percent a year, as expected.

Or let’s say you have $1 million socked away in your traditional IRA. At 70 1/2 you are required to withdraw a minimum of $38,250. At age 80, your annual MRD is up to$57,183 and by 90 you are required to withdraw $79,074.
But again there is money left in the account that has been earning an average of 5 percent a year and is still tax-deferred. At age 90, your account balance is $867,446, according to the fidelity.com calculator.

Yes, you may be paying more in income tax as you make these increasing withdrawals but there is peace of mind in knowing how this works and that the government gets those taxes at a slow rate. However, if you forget to make the MRD withdrawals, there is a harsh 50 percent tax penalty.

Next financial planning steps?
Once you figure what the projected MRD formula will likely be, start thinking about tax and inheritance strategies.  According experts, IRA accounts inherited by husbands and wives are treated differently in the tax code than IRAs inherited by children or other heirs. Surviving spouses can roll IRAs into their own accounts. If your IRA money goes to your children or other heirs and they want to continue the tax-deferred benefit, each must “roll his portion of the IRA into a separate account known as an inherited IRA, which comes with its own set of rules,” said advisers at Kiplinger.com. Visit your favorite CPA for estate planning and tax advice on this one.

Ways to manage the RMD transition:
-RMD withdrawals must be in cash. In advance of taking the annual distribution move a little more of your investment portfolio to cash. That way you avoid selling stocks or mutual funds to meet the RMD requirement at an inconvenient time. Click here for IRS link.

-Use a charitable distribution from your IRA to satisfy all or part of your annual MDR requirement. If you withdraw the money yourself, then donate, you will pay taxes on the distribution. If you don’t need the RMD cash, this is a great way to give “more” to your favorite charity. There may be reasons why this is not the best idea because of tax issues. So click here for a thorough look at this strategy at www.Forbes.com.

-Because they are taxed as ordinary income, RMD withdrawals can push you into a higher tax bracket. When added to your other income including Social Security, the tax bill can go up. If your total income exceeds certain thresholds, you could see as much as 85 percent of your Social Security benefit subjected to tax, experts say.

Bottom line: There is a lot to think about when setting up your RMDs. Naming beneficiaries, understanding inheritance rules and arranging charitable donations are worth looking into. My advice: Start studying up on RMDs now and talk to a tax professional who understands estate planning law. Good luck.

For more:
www.fidleity.com/retirement, click here
www.irs.com, click here.
ABCs of RMDS: Required Minimum Distribution  Rules for Retirement. click here.
Estimate your RMD distributions in retirement, click here.
RMD table at bankrate.com, click here.
AARP, click here.

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