Ask The CFP® Pract itioner
“You don’t have to see the whole staircase, just take the first step.” Martin Luther King, Jr.
Answer: The reason required minimum distributions (RMDs) must be taken from certain tax-deferred retirement accounts is that while you’ve been conscientiously saving for retirement, the IRS is patiently waiting to collect taxes on those funds.
A brief history lesson will help explain why age 59 ½ and 70 ½ are significant milestones. In 1934, the U.S. Railroad Retirement Board (RRB) declared age 65 as their official retirement age. In 1935, the Social Security Administration, which covers non-railroad workers, was established by the Committee on Economic Security, and at that time deemed age 70 as “normal” retirement age, based on old-world German standards.
As industry progressed and fewer Americans were employed by railroads, Congress addressed the retirement age issue again in 1962. At this time, the new “normal” retirement age for most employees covered by corporate pension plans was between age 65 or 70.
After consulting life insurance actuaries, Congress declared age 59 1/2 as the point where participants could begin accessing retirement account balances without an early withdrawal penalty. Based on life expectancy tables, and to maintain conformity, age 70 ½ was designated as the point when distributions must begin so the IRS could capture income taxes on these distributions over the life expectancy of participants.
The RMD amount depends on the account balance at the end of the calendar year in which withdrawals have to be made. To determine how much to withdraw in a given year, the previous year’s account balance is divided by the applicable divisor indicated in the IRS Uniform Lifetime Expectancy table.
For example, if you are now 82, your applicable divisor is 17.1. If the balance in your IRA as of December 31 of last year was $235,000, divide that amount by 17.1. The result is $13,742.69. This is the amount of your RMD for the current year.
Between age 59 ½ and 70 ½ you may take as much or as little as you’d like from tax-deferred accounts. There will be taxes due on most withdrawals, unless funds are coming from ROTH accounts, which are exempt from RMD rules since they are comprised of after-tax dollars.
As we approach year-end, this discussion is increasingly important for retirement account owners age 70 ½ or older who must take RMDs from Individual Retirement Accounts (IRAs), (SEPs), Savings incentive Match Plan for Employees (SIMPLEs) as well as many employer sponsored retirement plans. Steep penalties, up to 50% of the RMD if not taken in a timely manner may apply.
The initial required minimum distribution must be taken no later than April 1 following the year in which the account owner turned 70 ½. Subsequent distributions must be taken by December 31 of each calendar year for the rest of your life or until the account balance is zero.
As you can see, RMDs can be a complex topic. Depending on how you’ve prepared for this eventuality, RMDs may be viewed as an unwelcome nuisance, or the reward for a life well-planned. It’s never too early to consult your trusted financial advisor about incorporating retirement accounts and RMDs into your financial plan. What you do next matters. Stay focused and invest accordingly.
The information contained herein has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. We do not render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional.
“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame design) in the U.S.”
Darcie Guerin, CFP®, is Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email firstname.lastname@example.org. www.raymondjames.com/Darcie