Each year the time frame from Thanksgiving to Christmas seems to fly by to me. This time of the year is a hectic time for so many of us. With all the end of the year hustle and bustle, some new clients of ours had forgotten about some paperwork from their previous financial advisor that they feared might cost them a lot of money. They were concerned that they would not have time to take their first Required Minimum Distribution by the deadline. After we sat down for a bit and worked through the issue, I was able to put his mind at ease.
Tom and Georgia moved to the Cape about 20 years ago from Framingham, where they raised a family. After their kids went off to start families of their own, they decided to downsize to a cottage near the beach, where they’ve been ever since.
They are both active runners who participate in marathons, half-marathons and other races all around the New England area. They celebrated Tom’s 70th birthday in grand style this past April. His 70th fell a week before the Boston Marathon, so they ran the race together. They made it all the way, from Hopkinton to the Pru!
Tom’s birthday was in April, but he passed a milestone in October that didn’t even register with him: Tom turned 70 ½. At that age, who counts half-birthdays? I know somebody who does: our friends at the IRS. The age of 70 ½ is when the clock starts ticking to take Required Minimum Distributions (RMDs).
An RMD is the amount that each Traditional, SEP or Simple IRA owner (or employer-sponsored plan participant) must withdraw each year from non-Roth retirement accounts, after the owner or plan participant reaches age 70 ½. (Some folks who are still working at 70 ½ can delay taking RMDs, but it’s plan-dependent and subject to limitations.)
The RMD is based on the prior year-end value of the qualified retirement accounts from which a distribution is required, divided by the life expectancy of the account owner (as determined by the IRS).
Although Roth IRAs are generally not subject to RMDs, those that have been inherited are subject to certain RMD rules.
RMDs are reported as ordinary income on your tax return. Think about it: Uncle Sam is broke and wants his money (and he is not even your real uncle!). That’s why, at age 70 ½, he forces you to take a distribution from those tax-deferred accounts, even if you do not want to.
The paperwork that Tom had forgotten about was a note from his previous financial advisor reminding him to take an RMD. It was buried beneath other paperwork until he went on a desk-cleaning frenzy. He feared the worst!
Tom was concerned that it was too late and that he was going to get “dinged” by the IRS.
Fortunately, the clock hadn’t run out on Tom.
The IRS mandates that you take your first RMD by April 1st of the year after you turn 70 ½. Every RMD thereafter, however, must be taken by the end of each calendar year. Some advance tax planning comes into play here, because if you defer your first RMD until the tax year after you turn 70 ½, you will need to report two RMDs in that one tax year.
Fortunately for Tom, since this is his first RMD, he has a few more months before the deadline expires. During our meeting, Tom signed the necessary paperwork to process his distribution.
Folks, if you’re like Tom and you recently turned 70 ½, make sure you have a plan to take your RMD. If you miss the deadline, you might find yourself facing a stiff penalty: 50 percent of the RMD amount not taken. Additionally, you still must take the RMD (even if it’s late) and pay tax on that. So, it’s critical to get your RMD squared away in a timely fashion.
It is also helpful to understand that the distribution does not need to come from a single IRA account. Generally, you can take it from one or a combination of IRAs (with a few restrictions) if you want to avoid liquidating or excessively diluting a particular account, although there are some wrinkles to that. Please make sure you work with a retirement specialist to make sure your RMD is compliant and withdrawn in the most appropriate way for you.
You can do whatever you want with the distribution itself, short of converting it to another qualified retirement account (other than a Roth IRA if you are otherwise eligible to contribute to a Roth)—it’s your money. Some investors spend it, use it for vacation money, or pay off bills. Others reinvest that money in taxable investment accounts.
One way or the other, just bear in mind that generally, an RMD is taxable income. Your retirement or tax specialist can help you understand the tax ramifications of an RMD, especially if the additional income will push you into a new income tax bracket or affect other benefits.
RMDs can, however, be taken in such a way that they do not hit your tax return, if you are charitably inclined. You can direct your RMD to a nonprofit or charity as a Qualified Charitable Distribution (QCD). A QCD of up to $100,000 can be made without increasing your Adjusted Gross Income (AGI). That’s important for investors who might be subject to a higher Medicare premium or who may have more of their Social Security benefit subject to tax as a result of higher AGI from an RMD.
Just make sure that the contribution comes directly from the institution holding your qualified retirement account, not from you, and be aware that donor-advised funds are not eligible to receive QCDs. Also, the contribution needs to happen by December 31. Consult with your retirement and tax specialists to make sure your QCD is compliant with the rules.
In Tom’s case, he has approximately $200,000 in qualified retirement accounts, so he is required to take an RMD of about $7,300.
Tom and Georgia are generous folks who give time and money to a variety of nonprofits and charities. So, they decided to donate his first RMD to their favorite qualified charity as a QCD. That way, his RMD will not increase their adjusted gross income and they will be able to generously support their church.
Folks, Tom and Georgia are now better prepared for next year, when Tom will have to do this again—and when Georgia turns 70 ½. They learned that RMDs don’t need to be anxiety-inducing. With some careful management and appropriate planning, an RMD can be used to make your retirement years even better.
Be vigilant and stay alert, because you deserve more.
Have a great week.
Jeff Cutter, CPA, PFS is president at Cutter Financial Group, LLC, which has offices in Falmouth, Duxbury, and Mansfield. Cutter Financial Group provides private wealth and investment management advice incorporating low-risk, low-volatility financial strategies. Mr. Cutter can be reached at firstname.lastname@example.org.Cutter Financial Group LLC (“Cutter Financial”) is a registered investment advisor.This article is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Information regarding investment services is provided solely to gain a better understanding of the subject or the article. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable.Market data and other cited or linked-to content on in this article is based on generally-available information and is believed to be reliable. Cutter Financial does not guarantee the performance of any investment or the accuracy of the information contained in this article. Cutter Financial will provide all prospective clients with a copy of Cutter Financial’s Form ADV2A and applicable Form ADV 2Bs. Please contact Us to request a free copy via .pdf or hardcopy. This content cannot be used without the express written consent of Cutter Financial Group, LLC.