RMDs: Who? What? When? Where? Why? (and How!)

If you have a retirement account, and you’re about to turn 70 ½, you don’t want to miss your Required Minimum Distributions (RMDs) – because it will cost you… a lot! As in a 50% tax penalty! This article reviews the very important who, what, when, where, and why of RMDs, and gives a few ideas on how to reinvest the distributions.


Who: Retirement Account Owners

If you have a retirement account such as an IRA or 401k, in most cases, you have to start taking distributions from your account when you turn 70 ½. According to the IRS website:

You cannot keep retirement funds in your account indefinitely. You generally have to start taking withdrawals… when you reach age 70 ½… The RMD rules apply to all employer sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans. The RMD rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs. The RMD rules also apply to Roth 401(k) accounts. However, the RMD rules do not apply to Roth IRAs while the owner is alive.

What: Required distributions from your retirement accounts

Required Minimum Distributions (RMDs) are the minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age. The amount is calculated by the IRS based on actuarial tables and life expectancies. Generally speaking, your required minimum annual distribution starts out at slightly less than 4% of your account value according to this Finra RMD calculator.


When: Generally when you turn 70 ½

Generally speaking, you have to start taking the distributions in the year in which you turn 70 ½. However, the first payment can be delayed until April 1 of the year following the year in which you turn 70½. For all subsequent years, including the year in which you were paid the first RMD by April 1, you must take the RMD by December 31 of the year.

Where: From your Retirement account to another account

As described above, required minimum distributions must be taken from most retirement accounts. For example, you can withdraw the money from your retirement account and transfer it to your bank account (if you need the money for living expenses) or to a different investment account (if you’d like to keep investing a portion of it). Worth noting, in some cases, if you have more than one retirement account, you can calculate the RMD across all accounts, but then withdraw the total amount from only one account. According to the IRS:

An IRA owner must calculate the RMD separately for each IRA that he or she owns, but can withdraw the total amount from one or more of the IRAs. Similarly, a 403(b) contract owner must calculate the RMD separately for each 403(b) contract that he or she owns, but can take the total amount from one or more of the 403(b) contracts. However, RMDs required from other types of retirement plans, such as 401(k) and 457(b) plans have to be taken separately from each of those plan accounts.

How to re-invest your RMDs

If you’re going to keep investing a portion of your RMD within a different investment account then you’ll have to decide what types of investments make sense for you. And in our view, this is the fun part. For example, if you have a very low tolerance for risk then you may want to keep a significant portion of your money in cash (e.g. a bank account). However, understand that inflation will reduce the value of your cash over time, and it may make sense to move a little further our on the risk spectrum to earn a higher return than the rate of inflation (which is normally around 2% per year).

Bonds are another slightly higher risk investment that many investors consider. For example, 10-year US treasury bonds (considered very safe) currently offer a 2.42% yield. This is probably enough to overcome inflation and prevent the value of your money from decreasing, but it’s still a relatively low rate, especially compared to historical interest rates when the yield on US treasury bonds was much higher. There are also may high-grade corporate bonds that are relatively safe and also offer slightly higher yields than US treasuries, but again, interest rates are still near historically low levels, and this makes many bonds less attractive (especially considering rates are expected to rise in the coming years).

Stocks can be an extremely attractive investment if you are comfortable moving further out on the risk spectrum. Stocks generally offer higher price returns (and often attractive dividend payments) if you can tolerate the volatile ups and downs of the stock market. Generally speaking, stocks have the ability to return around 8% per year, on average, over the long-term (easily more than inflation and more than bonds), but stocks are also very volatile, and that 8% target return could come roughly in the form of negative 20% one year followed by positive 36% the next year. If you have the stomach to invest in stocks, we have a list of many dozens of stock ideas here: Blue Harbinger Free Reports, and we usually add several new ideas to this list every month.

Why: Uncle Sam wants the tax revenue

The government requires that you take distributions from your retirement account because they want the tax revenue. Remember, most retirement accounts have allowed you to make tax free contributions, but when you start withdrawing money the IRS taxes that money (at your ordinary income tax rate). However, you can use this opportunity (RMDs) to put your money in a better place. Specifically, you can use it to better enjoy your retirement (i.e. to pay your living expenses), or you can reinvest it more efficiently. For example, many retirement accounts charge expensive hidden fees that you can eliminate if you have the comfort level to become a "do-it-yourself" investor. And if you are not the "do-it-yourself" type, then you can use RMDs as an opportunity to find a professional advisor that you are comfortable working with. We generally recommend avoiding advisors that charge sales commissions (because this can create conflicts of interest). Instead, we prefer independent, fee-only, fiduciary advisors.

Conclusion:

Most importantly, don’t miss your RMDs because you will be taxed heavily. Specifically, you’ll be taxed at 50% on any RMD amount that you fail to withdraw. Also, RMDs provide the perfect opportunity to reassess your financial situation. Whether it be your bank account, a self-managed brokerage account, or a professional advisor, RMDs allow you to get your finances in order and put your money in a better place.

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