Required Minimum Distribution (RMD) for Retirement Income - Understanding the RMD and How to Get the Largest Tax Benefit from Your Distribution

It is that time of year again: Time to make sure you have met the required minimum distribution (RMD) from your retirement account by December 31. If you turned 70½ this year, you have until April 1 of next year to take your first RMD from your tax deferred retirement account. Most retirement accounts, except for ROTH IRAs, are tax deferred. This means you did not pay tax on the money when you or your employer contributed it to your retirement account. So, what is a required minimum distribution (RMD)? The required minimum distribution (RMD) is the minimum amount the IRS requires you to withdraw from your retirement account(s) each year to avoid being penalized.

The IRS does not allow you to keep your retirement funds in your IRA, SIMPLE IRA, SEP IRA, or retirement account indefinitely. These retirement accounts were designed to fund your retirement, not provide a way to transfer wealth to your heirs. One of the few exceptions is a ROTH IRA. Funds invested in a ROTH IRA do not have to be withdrawn until after the death of the owner. Keep in mind you can always withdraw more than the required amount. You just cannot withdraw less than your required minimum distribution (RMD) without facing a massive excise tax of 50% on the amount not withdrawn as required! Yikes! 50%!

How to Calculate Your Required Minimum Distribution

To determine your required minimum distribution (RMD), you start with your account balance as of December 31 preceding the calendar year you need to withdraw your RMD amount. You use that account balance and divide it by the distribution period from the IRS’ Uniform Lifetime Table.

Usually, your retirement plan broker or plan sponsor will calculate the RMD for you every year. If you haven’t received your RMD, do not delay and find out your RMD. You will need your RMD to plan accordingly, so you can avoid the 50% penalty. Do not wait until it is too late!

The IRS has a worksheet that includes the Uniform Lifetime Table and walks you through how to calculate your RMD, unless your spouse is the sole beneficiary and more than ten years younger than you. If both your spouse is your sole beneficiary and more than ten years younger than you, you can use the worksheet here to calculate your RMD.

Turning 70½ - When Does the RMD Apply?

The required minimum distribution applies the year you turn age 70½ for most taxpayers. The IRS calculates age 70½ by adding six calendar months to your 70th birthday.

Example. Dolores turned 70 on June 1. The IRS considers her to be 70½ on December 1 - six calendar months later.

The year you turn 70½, you have until April 1 of the following calendar year to take your first RMD. For years following the year you are required to start taking your RMD, you must withdraw it by December 31. This means if you delay your first RMD until April 1, you will need to take two RMDs that year - one for the preceding calendar year by April 1 and one for the current calendar year by December 31. You will need to take your second one for that calendar year by December 31.

Some taxpayers can wait until they retire before they are required to start taking their RMD. The terms of the retirement plan will decide whether you need to start taking your RMD at age 70½ or when you retire.

The 50% Excise Tax

If you do not take your required minimum distribution (RMD) or do not take the required minimum, the IRS accesses a 50% penalty in the form of an excise tax.

Example. Based on the Uniform Lifetime Table, you were required to take an RMD of $10,000 from your retirement accounts. You did not realize it until after the deadline and only withdrew $7,000. You would owe a 50% penalty on the difference of $3,000 ($10,000 RMD - $7,000 amount taken) or $1,500 ($3,000 x .50).

To avoid the 50% penalty, you need to take the minimum amount required. You can always take more, you just cannot take less than the required amount.

Required Minimum Distributions and Tax Planning: The Qualified Charitable Distribution

If you do not want all or part of your required minimum distribution, you can contact your retirement plan custodian and have them transfer the RMD to a qualified charity. To qualify, the charity must be a 501(c)(3) nonprofit. Or, if you normally donate to a charity, setting up the donation as a qualified charitable distribution provides a huge tax benefit. This is called a qualified charitable distribution.

This benefits you in two main ways: (1) you avoid getting penalized with the 50% excise tax by taking the RMD; and (2) you avoid paying income tax on the amount transferred to the charity. A win-win!

You cannot claim the amount transferred to the charity as an itemized deduction. However, you avoid paying income taxes on the amount transferred. This is a better tax break for the most taxpayers. This means, even if the itemized deduction is not the best deduction for you to take, you still get the tax benefits of making the qualified charitable distribution and taking the standard deduction.

Example. John gives $75 a month to his favorite charity. John turned 70½ and is required to take an RMD of $2,000. John files married filing jointly, and the standard deduction is his best deduction. His tax rate is 24%.

In the example above if John just gives $75 a month to his favorite charity, he will not qualify for any reduction on his taxes, even though, he donated a total of $900 for the tax year. However, if John used a qualified charitable distribution to donate the same $900, he would save $216 ($900 x .24). Just by setting up the qualified charitable distribution through his retirement plan custodian, it would only cost John $684 ($900 amount donated - $216 tax savings) to give $900. What a great way to give to yourself and a charity!

Because John’s RMD in the example above is $2,000, he would at a minimum to avoid the 50% penalty on the balance of $1,100 ($2,000 RMD - $900 qualified charitable distribution) need to withdraw an additional $1,100 before the deadline or make another qualified charitable distribution for the $1,100.

This means, if you normally give to a charity, including your church, throughout the year and are required to take a RMD, you will save more money at tax time, if you make a qualified charitable distribution from your retirement plan rather than just donating money from your pocket. Plan and save!

The Bottom Line

Understanding the required minimum distribution (RMD) you are required to withdraw from your retirement accounts is essential for tax planning. Ensuring you take your RMD can save you from being penalized 50%. If you are not sure if you are required to take a RMD this year or the amount of your RMD, contact your retirement plan administer. Do not delay! The deadline for taking your RMD is December 31 unless you turned 70½ this year.

Also, setting up qualified charitable distribution from your retirement accounts can save you from paying state and federal income taxes. This can be a huge tax benefit, especially if you normally give to qualified charities or do not need your RMD.

Required minimum and qualified charitable distributions can be confusing. To determine the best tax strategies for handling your required minimum distributions, schedule an appointment today with the accounting and tax preparation professionals at Gudorf Tax Group. Do not wait! Make sure you are using your retirement income to get the best tax benefits.