It’s not uncommon for our clients who are approaching the age of 70 ½ to begin dreading the thought of taking Required Minimum Distributions (RMDs) from their retirement accounts. Some believe that once they begin taking RMDs, retirement accounts will surely be depleted shortly thereafter. If you find yourself in what you think is this dreadful position, fear not… the first years of RMDs are really quite modest as a percentage of account value.
Calculating the RMD
There are two variables that go into the calculation of one’s RMD; the value of the retirement account on December 31st of the year prior to the year for which the calculation is being made, and the life expectancy of the owner of the retirement account according to the IRS Uniform Lifetime Table. (A different life expectancy table may be used for retirement account owners whose spouse is more than 10-years younger than they are.) Divide the prior year-end balance by the life expectancy, and you have calculated the RMD.
For example, John had $850,000 in his IRA as of 12/31/2014. He turns 70 ½ in August of 2015, so has a life expectancy of 27.4 years. $850,000 divided by 27.4 is an RMD of $31,021.90. This represents only about 3.65% of the account balance.
In subsequent years, one must revisit the Uniform Lifetime Table and again apply the account balance at the end of the immediately preceding calendar year to their then current life expectancy according to the table. In John’s case, if after taking his RMD in 2015 his IRA grows to $875,000 by year-end, he will apply his age 71 divisor of 26.5 to this new year-end balance to figure his 2016 RMD of $33,018.87.
Required Beginning Date
When must those RMDs begin? Does the first have to be taken by the time you turn 70 ½? The end of the month in which you turn 70 ½? The end of the year in which you turn 70 ½? Actually, the first year’s RMD is unique in that the Required Beginning Date is April 1st of the year following the year in which they turn 70 ½. (In all future years, it will be December 31st.) However, unless a person expects to have a change in taxable income in that year following the year in which they turn 70 ½, it may be prudent to take the first RMD before the end of the calendar year. If they wait to take it in that following year, they will be doubling up on taxable distributions from their retirement accounts.
For example, Sue turns 70 ½ in October of 2015. She is retired and her income doesn’t change much from year to year. Her RMD is $30,000 for 2015, but she can choose to wait to take it until the beginning of 2016, if she’d like. However, in 2016, Sue will have an RMD of $32,000, which must be taken by December 31st, 2016. For Sue, it would be better to spread out the taxable income over the two calendar years than add zero taxable income in 2015 and $62,000 in 2016.
Sue’s friend, Joan, shares a birthday with Sue and has the same amount saved for retirement, but Joan is still working and earns $90,000/year. She plans to retire in December of 2015, after which she will be living on Social Security and distributions from her investment accounts and retirement plans. In Joan’s case, it may be prudent to defer her 2015 RMD until after the first of the year, deferring the $30,000 taxable distribution into 2016 when she will have less taxable income as a result of her retirement.
Each person’s situation is unique, and what works well for one in consideration of RMDs may not work well for others. It is wise to consult with a professional prior to implementing a strategy for taking distributions.
So… what happens when the owner of the IRA dies? Do their beneficiaries have to take out the balance of the account and pay the taxes? Stay tuned for a run down on Required Minimum Distributions from Inherited IRAs.