When you’re putting together this year’s holiday shopping list, don’t forget to add one gift that you may need to give to yourself: a required minimum distribution (RMD). If you’ve reached age 70½, you’ll have to take an RMD from your 401(k), traditional IRA, or any other retirement plan that lets you shield your contributions from taxes. And the penalty for missing this obligation is a lot worse than getting a lump of coal in your stocking.
The funds that remain in your employer-sponsored retirement plans and IRAs can continue to grow without current investment or income taxes, but you must begin taking RMDs by April 1 in the year after the year in which you turn 70½. Thereafter, you must make the required withdrawal by December 31 of each and every succeeding year. So if you turned 70½ in 2016, you are required to take the RMD for the 2016 tax year by April 1, 2017—and now you must withdraw another RMD for the 2017 tax year by December 31, 2017. You'll pay federal income tax on these distributions, plus you may owe state income tax, too.
There’s an exception for employer-sponsored plans that may apply if you’re still working full-time and you don’t own 5% or more of the company. In that case, you can postpone withdrawals until your retirement. But you’ll still have to take RMDs from your IRAs.
How much do you have to withdraw? First, look up your life expectancy in the special IRS tables. If your spouse is the sole beneficiary for an account, his or her age also may enter into the equation. Distributions are based on the value of all of your accounts on the last day of the previous tax year. For example, suppose you’re age 75 and the value of all of your IRAs on December 31 of last year was $500,000. If your spouse is the sole beneficiary and is less than 10 years younger than you are, the withdrawal factor under the appropriate table is 22.9 Using an online calculator, you can determine that the RMD is $21,834.
Though the IRS requires you to take these withdrawals, if you have multiple 401(k)s or IRAs, it doesn’t care which account the money comes from. You can take the entire amount from one plan or divide up the RMD between or among other accounts.
What happens if you fail to take an RMD? The IRS can impose a harsh penalty equal to 50% of the amount that should have been withdrawn (or the difference between the required amount and any lesser amount that was distributed). For instance, if you failed to take the RMD in the example above, the penalty would be $10,917. That penalty is in addition to the regular income tax you owe on the RMD.
To be on the safe side, arrange to receive your RMD well before the December 31 deadline. You don’t want to be hit with a hefty penalty if there are any glitches.