It is December. As we come to the end of 2016, it is important for U.S. Retirees living in Dumaguete to understand the reason why 401(k) and Individual Retirement Accounts are called “tax deferred.” You pay no taxes while you’re accumulating savings in the 401(k) or IRA, but the IRS ultimately gets its taxes when funds are withdrawn. And to make sure the payment of taxes gets started on time, the Required Minimum Distribution rules states when you have to start taking distributions.
RMDs must be taken from IRAs starting in the year you turn 70.5 — and from 401(k)s at the same age, unless you’re still working for the employer that sponsors the plan.
RMDs are a double hit. First, the government requires you to pull money out of your accounts when you don’t necessarily want to. Failure to take the correct distribution results in an onerous 50 percent tax — and interest — on any required withdrawals you fail to take. Second, you are taxed on the distribution.
RMDs must be calculated for each account you own by dividing the prior Dec. 31 balance with a life expectancy factor that you can find in IRS Publication 590. RMDs must be taken by year-end, subject to one exception. If you turn 70 before July 2016, you will have turn 70.5 in 2016. You can take you first RMD in 2016 or wait and take it before April 1, 2017. If you wait until 2017, you will have to take two distributions in 2017 – one for 2016 and one for 2017. Note, if you turn 70 after July, 2016, than you turn 70.5 in 2017.
Although RMDs are calculated for each IRA you own, you don’t have to take a separate distribution from each account. You could total up all your IRA RMDs and take it all from just one IRA. With 401(k) plans, the RMD must be taken from each individual account you own. Not just from one account as is the case for IRAs.
If you’ve left a trail of 401(k)s at various jobs over the years, that can be a chore and a good argument for consolidation. If you’re just getting into the world of RMDs, it’s a good time to consolidate your 401(k)s and IRAs by minimizing the number of accounts you have, so you can keep track of them more easily.
If you’re over age 70.5, your option for minimizing RMDs is basically one. You can convert your IRAs into a Roth IRA. You’ll owe income tax on the money you switch into the Roth account in the year of the conversion, but you won’t need to take RMDs in future years. Plus, qualified distributions from the Roth IRA are income tax free.
It is important to remember the RMD rules kick in when you turn 70.5. If you turned 70.5 in 2016, you can take your first RMD in 2016 or wait and take it by April 1, 2017 for the 2016 tax year. Whatever your decision, you must take it your RMD. Not taking your required RMDs can result in a substantial penalty, additional taxes and interest. All of which can make you a very unhappy camper.
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Author’s email: wolff2000@earthlink.net
