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Retirees Should Know These 3 Facts About Required Minimum Distributions - August 27, 2020

If you do not make a required minimum distribution (RMD) from your own or an inherited IRA by the specified deadline, the IRS could hit you with a big penalty - 50%! For example, if you were required to withdraw a minimum of $4,000 and you did not, you would be obliged to pay $2,000. Plus, beginning January 1, 2020, the rules concerning RMDs were updated.

In case you're like most investors, you're probably trying to build a financial portfolio that is solid enough to guarantee a comfortable retirement. Among retirement financial planners, this is known as the "accumulation phase." In this stage, your objective is to carefully invest by selecting stocks with long-term potential for your retirement nest egg. For example, you might choose NextEra Energy (NEE), which is a current top ranked dividend stock.

But there is a second phase of retirement planning that gets less attention, even though it's the more enjoyable part. It's the "distribution phase," which simply means spending the assets you've worked so hard to accumulate.

Making plans for the distribution stage involves deciding where you'll live in retirement, whether you'll travel, your proposed leisure activities, and more decisions that will affect your spending during your golden years.

Along with those choices, you need to be mindful of the RMD, because it applies to the majority of retirement accounts. This IRS rule requires you to withdraw a specific minimum amount from any qualified accounts you have when you reach a certain age--previously it was 70 1/2, but beginning in 2020, it is 72.

What is the point of this mandatory withdrawal by the IRS? Not surprisingly, it's to be sure that the government gets their tax money. Without the RMD requirement, individuals could live off other income and never pay tax on retirement account gains. That cash could be left to family or friends as an inheritance and the IRS would not receive taxes from it.

The Most Important Things to Know About RMDs

Which types of retirement accounts have RMDs? Qualified retirement accounts like IRA accounts, 401(k)s, 457 plans and other tax-deferred retirement savings plans like a TSP, 403(b), TSA, SEP, or SIMPLE IRA plan require withdrawals in retirement.

When does it become necessary to begin taking distributions? Your first distribution must be taken by April 1 of the year following the calendar year that you turn 72 (for most accounts). Also, if you retire after that age, you must take your first RMD from your 401(k), profit-sharing, 403(b), or other defined contribution plan by April 1 of the year after the calendar year in which you retire.

For each year after your required starting date, you must take your RMD by December 31. Note that you don't need to take an RMD on a Roth IRA since you covered taxes before contributing. Other varieties of Roth accounts require RMDs. But, there are approaches to avoid them - for instance, you can roll your Roth 401(k) into your Roth IRA.

What will happen if I neglect to take my RMD? If you don't take an RMD, or don't take a large enough distribution, you are liable for a 50% tax on the amount that was not withdrawn in time.

How much money do I have to withdraw? To calculate a specific RMD, you must divide your prior year's December 31st retirement account balance by a "distribution period" factor based on your age.

Here's an example to give you an idea of the math: Ann is 71 and will take her first RMD in the year following the year she turns 72. Her IRA balance toward the end of the preceding year was $100,000. Her "distribution period" factor is 27.4. Dividing $100,000 by 27.4 equals $3,649.63. This is the amount Ann is required to withdraw for her first RMD.

Learning about the "distribution phase" is just one aspect of preparing for your nest egg years.

To learn more about the tax implications of retirement spending - and much more about retirement planning - download our free guide: Retirement Made Easy.


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