You’ve heard the advice before: First, the earlier you start saving for retirement, the better. Second, if you have access to a tax-deferred account, such as a 401(k) or traditional individual retirement account (IRA), take advantage of the tax benefits they offer.
But the money you put into these accounts can’t sit there forever. At age 72, you’ll need to start taking what’s known as a required minimum distribution, or RMD. Here’s what you need to know, and why you should be thinking about them before you turn 72.
What is an RMD?
An RMD is the minimum amount the government requires you to withdraw each year from any tax-deferred account beginning at age 72. Because these accounts are funded with pre-tax dollars, you’ll have to pay taxes when taking an RMD. (Note that this does not apply to Roth IRAs since you already paid taxes on those funds).
How much do you need to withdraw?
To calculate your RMD, there’s a relatively simple formula to follow. First, tally your retirement account balances as of Dec. 31 the previous year. Then, divide that number by your age’s corresponding life expectancy factor, which you can find in this table. (The IRS also offers worksheets to help you calculate).
If you have multiple IRAs, you’ll need to calculate your RMD for each separate account. While the separate calculations are mandatory, you can, however, choose to withdraw the total amount from just one account to simplify the process. But if you have multiple 401(k)s or other employer-sponsored accounts, you must take your RMDs by individual account.
What happens if you don’t withdraw?
If you don’t take your RMD, you will be hit with a penalty of 50 percent of the amount you were supposed to have withdrawn, in addition to the taxes you’ll owe.
When do you have to take RMDs?
You can wait until April 1 of the calendar year after you turn 72 to take your first RMD. So if you turn 72 in September 2022, you must take your first RMD by April 1, 2023. After that, you’ll need to make your annual withdrawal by Dec. 31 of each year. While you can hold off taking your first payment, it also means taking two withdrawals in the calendar year you turn 73. That could push you into a higher tax bracket in that year, so you’ll want to talk to an advisor about what makes the most sense from a tax perspective.
Using RMDs in retirement
Knowing the minimum amount you’ll need to withdraw from your savings each year is an important factor in planning for retirement. In addition to taking the required amount (to avoid a penalty), managing your RMDs can be an important part of tax management in retirement.
Consider converting a traditional IRA into a Roth. If you roll over your traditional IRA into a Roth account, you won’t have to take an RMD. (However, you will need to pay taxes on the funds in the year that you complete the rollover). A financial professional or tax advisor can help you determine what makes the most sense for your situation.
Start penalty-free withdrawals once you’re eligible. At age 59 ½, you can start withdrawing from your retirement savings without incurring a penalty. Having a smaller account balance can help offset larger RMDs.
Roll over your accounts if you’re still working. If you’re still working at 72, you may be able to roll over your savings into your current employer-sponsored plan. If so, you’ll be able to hold off taking RMDs from the plan until you retire.
Diversify your retirement income sources. Putting all your retirement savings in a 401(k) or IRA may seem like a great idea while you’re saving for retirement. But when you get to retirement, you’ll be required to withdraw that savings and pay tax on it. By using a range of financial options, including Roth accounts, permanent life insurance cash value, annuities and more, you’ll have more flexibility in retirement to manage your retirement income in a way that can help you minimize taxes and hedge against other potential risks.
Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.
See how much monthly retirement income you may have based on what you’re saving now.