What Baby Boomers need to know about RMDs and how they can prepare.
It has been said that “all good things must come to an end.” That may not be true in all cases, but when it comes to postponing taxes within your pre-tax IRA or 401(k), it’s very much true. Whether or not you need the income, at a certain point, the IRS will force you to begin withdrawals from your IRAs and other pre-tax retirement plans. Upon withdrawal, those monies are taxable as income. For baby boomers, this “out in the future” requirement is becoming a reality. Reason being, the first of the baby boomers turned the magic age of 70 ½ on July 1, 2016. This magic age begins the IRS’s Required Minimum Distribution (RMD) rules.
RMDs, like many government requirements, can be confusing. There are a few things to be mindful of, some of which may require you to seek the counsel of a tax professional or Certified Financial Planner™. You must take the first RMD from your IRA(s) by April 1 st of the year following the year in which you turn 70 ½. But the first RMD is for the year in which you turned 70 ½.
Let’s look at an example:
Chip was born January 1, 1946. He is retired and due to part-time work and a pension from his previous employer, he has not begun withdrawals from his IRA. As of July 1, 2016, Chip is the magic age of 70 ½. This means that by April 1, 2017, he must take his first RMD (for 2016) from his IRA, and if he’s no longer working, from his 401(k)s as well.
But here’s the tricky part. While Chip can wait until April 1, 2017, to take his RMD for 2016, that does not prevent him from having to take the RMD for 2017 by December 31 st of 2017. That would mean two RMDs in one year.
For many folks, two RMDs in one year can cause a significant increase in income, which impacts federal income taxes both in terms of their tax bracket, and potentially as it relates to Social Security benefit taxation as well. And on top of that, an increase in income could potentially cause a bump up in Medicare premiums. These are potentially very impactful consequences that many people simply are unaware of until it’s too late. Rest assured, Uncle Sam wants his piece of the pie and won’t check to see if you’re ready.
What can baby boomers do to prepare?
The most important thing is to be aware of when you will turn 70 ½. Remember, your first RMD(s) will be required for that year. Next, you will need estimate your RMD(s) using either a RMD calculator or appropriate worksheet. RMDs are calculated using the account balance from the prior December 31 balance.
Using our friend Chip, let’s say his IRA balance was $500,000 on December 31, 2015. If Chip’s spouse isn’t less than 10 years younger than he is (another caveat), his RMD will be just over $19,000. If Chip also has a 401(k) from his previous employer, he must take an RMD from that account as well. If that account is roughly the same size, he’s looking at close to $40,000 of additional income. And let’s remember our “April 1st of the following year” note from the beginning. If Chip chooses to wait until 2017 to take his initial RMD, he will have close to $80,000 in additional income for 2017—the RMDs from 2016 and 2017 combined. It’s clear to see how this could have a significant impact on his tax situation (and potentially on Medicare premiums).
For some retirees, however, RMDs will have little or no impact on their financial situation, as they’re already withdrawing funds annually from their IRAs to support their retirement living expenses. The IRS does not require you to take an additional amount of money; it simply requires that if you’re already withdrawing (which you can begin to do without penalty at 59 ½), that you’re withdrawing enough by 70 ½. Meaning, if Chip already withdraws $20,000 a year from his IRA for living expenses, he is satisfying the RMD requirement for his IRA (which we estimated to be $19,000).
After you’ve calculated what your RMD will be and determined if it will require a new or additional withdrawal from your IRA, consider your current income sources. A quick comparison to the federal income tax brackets can give you an idea as to whether your RMD may push you into a higher bracket. But remember that multiple layers of complexities (tax rules, Medicare rules, required accounts) may mean it’s time to consult a Certified Financial Planner™ to map out a plan. We work with our clients to develop a plan for the withdrawal of assets and cash flow, specifically as it relates to taxation and the other quandaries mentioned above. There are many moving pieces, which may require careful planning. To learn more about how we can help, contact us or visit our Financial Planning page.