Claudia Buck

Stay on top of retirement account withdrawals to avoid tax penalties

Donna Freeman isn’t ready to retire. But she’s nearing a deadline facing many baby boomers who are close to turning 70.

That deadline is one the IRS doesn’t want her to miss: taking the first required withdrawal from her IRA and other retirement accounts.

The Sacramento resident, who turns 70 in August, said she has “so many questions” about when and how much to take in mandatory withdrawals from her multiple IRA accounts.

For those who turned 70 1/2 in 2014, that deadline is Wednesday.

But the IRS wants folks to be aware. “Each year as taxpayers with traditional IRAs turn 70 1/2 years old, the IRS reminds those taxpayers that they’ll need to start receiving required minimum distributions from their IRAs, (including) workplace retirement plans like 401(k), 403(b) and 457 plans,” David Tucker, IRS spokesman in Seattle, said in an email. (The RMD rules do not apply to Roth IRAs while the individual is alive.)

Those mandatory withdrawals can be overlooked.

Kevin Young, a certified financial planner and tax preparer in Davis and Sacramento, said he’s had new clients come in at age 73 and older who’ve never taken an RMD from their retirement accounts.

Although retirement account companies are supposed to notify clients when they reach the RMD age, those notices may not get issued or they could be overlooked by individuals.

In some cases, “They’re not informed, or they don’t understand it. Maybe they’re not reading their statements or weren’t communicating with their adviser,” said Young, owner of Young Wealth Management.

In most cases, they should take all of the required withdrawals in that same year, which is treated as taxable income.

There’s also a stiff fine for failing to take the required distribution. Under federal tax law, the penalty is 50 percent of the required distribution amount. For example, if you were supposed to take out $11,000, you’d owe $5,500 in penalties.

“It’s one of the biggest IRS penalties out there,” Young said.

The logic behind that, notes Young, is that Americans have been able to squirrel away their retirement savings – tax deferred – for all those years. But after reaching the mandatory age-70 cutoff, the IRS is ready to get some of that long-tax-deferred income.

How to calculate what you owe each year?

“If you are somebody who’s a do-it-yourselfer, make sure you understand the rules,” said Young. Essentially, it’s the balance of all your IRA and retirement accounts as of Dec. 31 each year, divided by your distribution period – taken from the IRS Life Expectancy tables.

As an example, Young said, take someone who’s 71 this year and has a distribution period of 26.5 years, according to the table.

“Let’s say they have $300,000 in an IRA,” he said. “You divide by 26.5 and they’re going to have to take out $11,321 this year. It’s all ordinary income, so it’s all taxable income they’ll need to report on this year’s tax return.”

(That distribution period drops each year, the older you get. By the time you’re 85, for instance, it’s 14.8.)

If you have multiple traditional IRAs, you can take the total RMD amount due that year from just one account if you like. The same is true if you have multiple 403(b) accounts. For 401(k) accounts, however, you have to make separate RMDs from each account.

And even if you’re not in that age bracket now, it’s good to have it on your radar. For one thing, it’s not always the best move to wait until April 1 of the year after you turn 70 1/2.

“The downside to waiting is that you have to take two distributions that year: one by April 1 and one by Dec. 31,” said Young. “All of that is ordinary income, so it could put you in a higher tax bracket.”

For those with decades of work history and multiple retirement accounts, it can be easy to overlook an IRA. That’s why Young recommends that clients consolidate multiple IRAs into one account, in most cases.

“It’s all a little confusing,” said Freeman, who works for a Roseville commercial property management company. Even though she has no immediate plans to retire, “I just want to know the best way to proceed.”

Call The Bee’s Claudia Buck at (916) 321-1968 or read her Personal Finance columns at sacbee.com/claudiabuck.

Quick look at RMDs

What: Officially known as a required minimum distribution, an RMD is the amount you’re required to start taking annually from your IRA and other retirement accounts, starting the year you turn 70 1/2. (Note: It does not apply to Roth IRAs.) It’s a minimum requirement; you can take out more each year, but all withdrawals are treated as regular income.

Deadlines: Typically, you must take your annual withdrawal by Dec. 31 each year, starting at age 70 1/2. But the first year, the IRS gives you until April 1 to make that initial RMD. For example, if you hit 70 1/2 in March 2014, you have until April 1, 2015, to take your first required withdrawal. Thereafter, the RMD must be taken by Dec. 31 each year.

Exclusions: If you continue working past age 70, you are not required to take an annual RMD from your current employer’s 401(k) or 403(b) account until you retire. But you must still take RMDs from your traditional IRA accounts, including 401(k)s that were rolled over.

Penalties: If you fail to take your mandatory RMD, the IRS tax penalty is 50 percent of that year’s RMD. Also, with a few exceptions, if you take money out of your IRA before age 59 1/2, there’s a 10 percent penalty for those early withdrawals.

How to calculate: The annual RMD is based on the total sum of your retirement accounts as of Dec. 31, divided by your distribution period, as listed in the IRS Uniform Lifetime table, found in IRS publication 590. The distribution period is determined by your age and drops each year. You can go to IRS.gov, which has tables and worksheets to calculate your RMD.

More details: Go to IRS.gov. Or contact your employer, financial adviser, tax preparer or retirement account custodian if you have additional questions.

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