Time is running out in 2018 for certain retirees. If you are older than 70½ and don’t take a “required minimum distribution” (RMD) from your qualified retirement plans and traditional IRAs, you could owe a hefty tax penalty to the IRS.
If, however, you just turned 70½ this year, you have until April 1, 2019 to take RMDs. But it often makes sense to arrange payouts before New Year’s Day anyway.
First, let’s review the basic rules. Distributions from qualified retirement plans, like 401(k)s and traditional IRAs, are generally taxed as ordinary income at rates currently reaching up to 37 percent. If you withdraw funds prior to age 59½, a 10 percent penalty also applies on top of the regular income tax.
Furthermore, although payouts from qualified plans and IRAs don’t count as “net investment income” (NII) under the 3.8 percent NII tax, RMDs still increase your modified adjusted gross income (MAGI) in this calculation.
To make matters worse, you must begin taking lifetime RMDs from qualified plans and traditional IRAs— but not Roth IRAs—no later than April 1 of the year following the one in which you turned age 70½, and you’re required to do so each succeeding year. For instance, if your 70th birthday was June 15, 2018, you have to take an RMD for the 2018 tax year by April 1, 2019 and then another for the 2019 tax year by December 31, 2019.
Practical advice: Frequently, it makes sense to arrange your first RMD by December 31, 2018 and then take the one for 2019 at any point next year. As a result, you avoid “doubling up” on RMDs in 2019, which could increase your overall tax liability.
Generally, the amount of the RMD is based on IRS-approved life expectancy tables and the value of the account on the last day of the previous tax year. Therefore, the distributions for 2018 depend on your account balances on December 31, 2017, even though you're withdrawing the funds almost one year later.
Key point: If you’re still working full-time for an employer where you have a qualified plan and you’re not the business owner, you can delay RMDs until your retirement. This “still-working exception” only applies to employer-sponsored plans—not to IRAs.
Also, note that you don’t have to take RMDs from any one account. You can divide up the distributions any way you see fit as long as the total equals or exceeds the required amount. This gives you some flexibility at the end of the year.
What’s the penalty for failing to take an RMD? Well, it’s equal to 50 percent of the amount that should have been withdrawn (or the difference between the required amount and a lesser one actually withdrawn)—on top of the regular income and NII taxes you may owe.
For example, if you neglect to take a $10,000 RMD in 2018, the penalty, just by itself, is a whopping $5,000! This is a powerful incentive to get all your ducks in a row before year's end.
Finally, be aware RMDs may also be required if you own plan accounts and IRAs inherited from a family member. Although lifetime distributions from a Roth IRA aren’t mandated, you must take RMDs from one you’ve inherited.
It may take a while to go through the process, especially if you’re using snail mail to handle the paperwork, so don’t procrastinate. Make arrangements well before the December 31 deadline rolls round to avoid any unnecessary complications.
About Ken Berry
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.