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Tax-deferred investment vehicles such as traditional IRAs and 401(k)s are excellent tools for storing and growing dollars for retirement. Getting a tax break with the initial contribution and having those dollars grow accordingly helps folks navigate life once careers come to a close. However, investors must be mindful, that, upon withdrawing these assets in retirement (or at least after age 59.5), Uncle Sam is going to want his money. Distributions at that time will be taxed at their ordinary income tax rate. Should an individual be willing and able to avoid withdrawals from these tax-deferred accounts throughout their 60s, they will have no choice but to start taking out a certain amount annually, beginning at age 70.5.

Thus enters the topic of required minimum distributions or, more affectionately, simply RMDs. The IRS has a formula and table that allows you to calculate (based upon prior year December 31st account values) what you must distribute from your tax-deferred portfolio each year. The idea is to get an investor to draw down your account over your actuarily calculated remaining life span. Seems like a nice gesture!

You don’t have to spend the money, but it has to come out. You can have it reinvested in a taxable/non-qualified account, put it in the bank, bury it in the backyard, whatever, but you cannot funnel it back into the retirement account. If you have multiple IRAs, you only have to take that total distribution from one account if you so choose. Company retirement accounts like 401(k)s and 403(b)s must have RMDs taken from each. If you have a 401(k), are still actively employed with that company and have less than 5% ownership in the organization, you do not need to start withdrawing from that bucket of money until you are officially retired. If you are an owner of 5% or more of the company, you must start RMDs out of the group plan.

Little known/interesting fact: Roth 401(k) assets (taxes already paid) are still subject to an RMD (unlike if those same dollars were in a Roth IRA). If you are unsure if you have Roth 401(k) assets, check with your plan or advisor. The reason is because all 401(k)s have RMD obligations, regardless of account type. If that’s you, let’s chat on how to avoid that (rossp@fostergrp.com).

The penalty for not taking your RMD is significant; 50% excise tax is a fantastic encouragement not to forget. This calculated amount must come out by year-end. In the year you turn 70.5, the IRS allows you to take your first distribution by April 1 of the following year, although that means you will have two required distributions in one year. Clear as mud? Many rules and specifics surround RMDs, and the ramifications are significant if you mishandle the process. Spousal and inherited IRAs and annuities are a whole other level of complexity, with respect to RMDs and outside the scope of this blog. Engaging your trusted financial advisor is key in managing your withdrawal strategy to ensure avoidance of critical mistakes.

One fairly new alternative to taking your RMD and paying the resulting tax is gifting that amount (up to $100,000) to a qualified charity. For more information about this strategy, read Charitable Advantages of Owning an IRA, written by Walt Mozdzer earlier this year.

Retirement is a time to enjoy the fruits of your labor, not stress about the perils of financial mistakes. Whether you are north of 70.5 or fresh out of college, you can prepare for required distributions by developing an efficient withdrawal strategy. This goes well beyond what accounts to take money from but dives deep into the territory of what investments to liquidate within those accounts. For those accumulators in the crowd, utilizing Roth vehicles and non-qualified investment accounts serves as a fantastic tool to lessen future RMD strangleholds and enhance withdrawal (and tax) strategies down the road. Aside from that, stay diversified.


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