The 3 Letters Boomers Will Soon Understand–RMD
The IRA and its work companion 401(k) are wonderful things that were designed to help people cope with a non-defined benefit (non- pension) world. We all know pensions are largely a thing of the past.
Beginning in the 80s the idea of saving in the workplace through 401(k)s, and outside the workplace with IRAs, represented a big leap forward in encouraging savings for retirement. To encourage savings the government offered the opportunity to delay (but not forever) tax payments on dollars socked away in traditional 401(k)s and IRAs. Later on, Roth 401(k)s and Roth IRAs were introduced where after-tax dollars were paid in, and therefore were there were no taxes owed on the principal or the appreciation when withdrawn later in life.
However, for Boomers who have largely used the traditional IRAs and 401(k)s, the day of reckoning is upon us.
The day of reckoning is spelled R-M-D.
What’s an RMD? Simply it’s a required minimum distribution on a traditional IRA that is required (that word again) beginning at age 70-1/2. Wait a minute aren’t the early Boomers (born 1946) now 70. Yup. And the taxman cometh and he won’t be denied.
What if you don’t take required distributions, purposely or even mistakenly? No sweat–the government assesses a “small” penalty (50%!) on the monies that were to be have been withdrawn. What! Yup. 50%. Those 70-1/2 must take the required distribution or risk the mega penalty. The distribution varies annually and starts at roughly 3-4% of the balance of your IRA and then the percentage increases annually as you age.
And the distribution is then taxed at your ordinary income rate. If you were a great saver and socked away $1Million+ in your IRA, Uncle Sam will be taking a big piece of that away in taxes and you need to plan accordingly.
My thoughts to leading edge Boomers now age 70 and those near 70 are simple.
1. First, find all those 401(k)s from your employment life.
2. Next, roll these all (directly—be careful that they are not cashed out) into a single IRA—you won’t avoid taxes, but at least you won’t be chasing down the RMDs of multiple accounts
3. Do some planning based on the size of your IRA and use a distribution calculator to see the size of the distributions. Then see how this will affect your taxes. Remember the withdrawals are taxed as ordinary income. If you take withdrawals in excess of the RMD that’s fine too. More $ for you, more for Uncle Sam too.
4. Be sure to check with the place where your IRA resides and have the distributions done automatically. Again you won’t avoid taxes, but at least you’ll avoid the penalty
IRAs/401(k)s are wonderful things that helped some Americans save for a pension-less world. We Boomers never thought about the tax implications later in life. We just liked saving a few dollars in the 80s/90s/00s. But Uncle Sam was always our partner, and payday is near.
For my children and other Millennials, my advice is simple. Start saving early and go Roth, young man (and lady). Don’t try to save some modest tax dollars now and get socked later. The benefits and flexibility of a Roth are many including—ability to withdraw principal at any time after 5 years, no required distributions, and no taxes if/when you do.
For us Boomers it’s largely too late and you need to plan to pay taxes on your IRA withdrawals. Plan for it, don’t be surprised and factor the taxes into your future financial plan and you’ll be fine. But don’t stick your head in the sand or you’ll get socked with mega penalties and the taxes too. Nothing is easy.