10/16/2015 Written By: Steve Hengehold, Retirement and Financial Planning.
Just what are these Required Minimum Distributions (RMDs)
If you are over 70 ½, the IRS requires that you take a distribution from your tax-deferred IRA each year. That doesn’t mean you have to spend the money – for example, you can re-invest the distribution in a taxable account – but it does mean you owe some taxes. That was the deal when you signed up: tax deductible contributions on the front end, and years of tax deferred compounded earnings on your investments…with the agreement that you pay income tax in the future when you take the money out. Naturally, keeping track of how much money you owe is one of Uncle Sam’s strong suits.
The IRS determines the minimum amount you must distribute and pay taxes on each year with a formula that uses your age and the value of the tax deferred account. If you fail to take your RMD, you face some hefty penalties. The penalty for a missed distribution is 50% of the amount you failed to take. That means if you failed to take an RMD of $10,000, you would owe a $5,000 penalty in addition to the tax you already owe (ouch!).
Which Accounts are subject to Required Distributions?
In general, accounts that received deductible contributions are subject to RMD requirements. That means Traditional IRAs, simplified employee pension (SEP) IRAs, and SIMPLE IRAs are subject to the RMD Rules while you are alive.
The big exception from RMD rules is the Roth IRA. As the tax law is currently written, you are not required to take distributions from your Roth IRA ever (in your lifetime… the rules change a little bit for Inherited Roth IRAs). And with a Roth IRA, you actually paid taxes before you contributed money to the IRA. The contribution was not deductible, but you do not owe taxes on the distribution of your principal contribution as long as you’ve satisfied the 5 year-rule. The 5-year rule requires that the contribution was made at least 5 years ago. If you satisfied all of those conditions, your earnings are distributed tax free as well!
But what if I’m still working?
If you work past 70 ½ and are participating in a plan, you likely will not be required to take distributions from the plan in which you are currently participating. This exception does not apply to Traditional IRAs or qualified employer-sponsored plans from a previous employer.
Remember – when in doubt, contact your plan administrator or a qualified retirement planning firm. The Cincinnati firm of Hengehold Capital Management provides wealth management and retirement planning services.