Advertiser Disclosure

Avoid Pitfalls as Retirement Distribution Deadline Nears

Dec. 26, 2016
Investing, Retirement Income
Many or all of the products featured here are from our partners who compensate us. This may influence which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. Our opinions are our own.

The IRS defers taxes on many retirement accounts. But at a certain point, the agency wants to start collecting its due.

The way it does so can feel like an abrupt change, especially if you’ve spent decades considering those accounts off limits. You must start taking required minimum distributions, or RMDs, at age 70½.

Know the rules

RMDs are required from tax-deferred retirement plans: traditional individual retirement accounts, SEP and Simple IRAs, and workplace plans like 401(k)s. They’re not required from Roth IRAs.

If you’re still working at 70½, you can delay distributions from your employer plan until you retire, unless you own 5% or more of the business.

In general, you have to take your allotted distributions by Dec. 31 each year. RMD first-timers — those who turned 70½ just this year — get an extension to April 1.

Procrastinators can take comfort in the fact that they’re not alone. Fidelity Investments says that as of Dec. 2, 41% of its IRA customers due for RMDs had not taken any. But comfort won’t pay the 50% penalty the IRS levies on money you don’t distribute in time.

Tips for taking RMDs

If eligible, decide if you want to use an extension. Using it means you’ll have to take both this year’s and next year’s RMD in 2017. That matters because these distributions are taxed as income.

“I’ve been doing this for 30 years, and I’ve never seen anyone who benefits from waiting,” says Neal Frankle, a certified financial planner and founder of Wealth Resources Group in Westlake Village, California. “The only benefit is that if you forget to do it by the end of the year, you don’t have to pay a penalty.”

However, if you’re in a high tax bracket this year and you expect to be in a lower one next year, it might make sense to push this income off.

Get the process rolling. The amount you need to withdraw is based on an IRS calculation that divides your account balance at the end of the prior year by a life expectancy factor for your age. The RMD will be calculated separately for each retirement account, and account providers typically do the math for you.

But the high percentage of procrastinators means those providers are flooded with RMD requests this time of year. The earlier you get in line, the better, says Maura Cassidy, vice president of retirement at Fidelity. “It might take some time to sell [investments] and settle the amounts needed,” she says.

Generally, you can elect to sell a proportionate amount of each of your investments to satisfy the distribution, or a fixed percentage from one or two investments. “Some people want it to come 100% from XYZ fund, but others may want to keep their asset allocation and sell proportionately from all of their holdings,” Cassidy says. If your account has a cash allocation, you can pull the RMD from there to avoid selling stocks or mutual funds.

If you have more than one IRA, you can aggregate your RMDs and take them all from one account or pull from each IRA separately. If you have more than one 401(k), you’ll have to take an RMD from each account that requires one.

Let money you don’t need continue to grow. If you’re fortunate enough not to need this income, it’s a bummer that the IRS is forcing you to give up tax-deferred investment growth. You can cling to the growth, though not the tax deferral, by reinvesting your distribution in a taxable brokerage account.

Going forward, think about how and where you’re drawing income each year. You may want to get help from a financial advisor. This planning is especially important if you have multiple pots of money with different tax treatments, like a Roth IRA or taxable account in addition to traditional IRAs or 401(k)s.

Do better next year. Ask your plan administrator to calculate your RMD amount automatically at the end of each year and send you a distribution each month or each quarter, just like a paycheck. You can factor it into your income needs, and you won’t have to think about a quick-turnaround December distribution — or worse, the prospect of a potential penalty.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: [email protected]. Twitter: @arioshea.

This article was written by NerdWallet and was originally published by The Associated Press.