Happy April 1st! Did you know that April Fools’ Day is also called All Fools’ Day? Did you also know that it may have started in the 16th Century due to a calendar change? That calendar change was a switch from the year starting in April to the year starting in January. Another theory ties it to the “vernal equinox,” which is the first day of spring in the Northern Hemisphere, but the weather doesn’t always behave Spring like (I know my New York clients will believe this!).
For those of us in the personal finance world, it is a date that carries different meaning to us! It is the last day you can defer your Required Minimum Distribution the year after you turn 70½, no April fools there, we don’t want you to miss that date and pay the 50% penalty!
Understanding Required Minimum Distributions
By Financial Planner Scott DuMond, CFP®
“I turned 70 this year, isn’t there something I am supposed to do with my retirement accounts?”
The topic for today’s lesson is IRS Minimum Distribution requirements at age 70 ½. The IRS has a nasty penalty for not taking the required Minimum Distribution withdrawal, 50% of what you should have taken… and that’s no April fool.
I tell my students and clients that understanding Minimum Distribution requirements are like cutting an onion. There is always another layer, and the deeper you go, the more you cry. I am never sure if I am joking or not, so let’s take this one layer at a time. Out of respect for you and your tear ducts, we will stick to the first few layers. Please do understand that there is always another layer and it is worth talking to your financial advisor or tax professional as you approach age 70.
Layer One
If you have turned 70 or are turning 70 this year, be sure to talk with your tax advisor or financial planner. They will tell you what you need to do and when. The simple answer is either this year or next you will be required to take a withdrawal from your 401ks or IRAs of approximately 4% of your total.
That’s it. Feel free to stop reading here and talk to your financial professional. If you want to keep reading I will keep explaining. However, feel free to come back to Layer One at any time.
Layer Two
Exactly when do I have to take this withdrawal?
A person is required to take their first minimum distribution withdrawal the April 1st of the year following the year they turn 70 ½. *
Example 1:
Fred turns 70 in May of 2019. He then turns 70 ½ six months later in November of 2019. He will have to take out a distribution before April 1 of 2020.
Example 2:
Wilma turns 70 in July of 2019. She then turns 70 ½ six months later in January of 2020. She will have to take the distribution before April 1 of 2021. (The April 1st of the year after the year she turns 70 ½.)
Layer Three
When should a person take their first minimum distribution withdrawal?
They should take it the year they turn 70 ½ and not wait until the following April.
Example 1:
Fred turned 70 ½ in November of 2019. He therefore should take his withdrawal in 2019. The IRS gives you until the following April in case you didn’t know and needed to be told by your tax advisor.
So Fred could actually take his first withdrawal anytime between January 1st 2019 and April 1st 2020. He should keep in mind that this becomes an every year thing. He may want to be sure to take the first withdrawal in 2019 so he doesn’t have two withdrawals in the same year. The first one by April of 2020 and the second one by December of 2020. That could hurt come tax time.
Example 2:
Wilma turned 70 ½ in January 2020. She therefore should take her withdrawal in 2020. Wilma could take her withdrawal anytime between January 1st 2020 and April 1st 2021 and still be in compliance.
Layer Four
Exactly how much do I have to withdraw to stay in compliance and make the IRS happy?
This is a simple math problem. Find out the balance of all of your 401ks, IRAs, and other retirement accounts as of the December 31st of the year before the year your turn 70 ½. Divide that number by 27.4 if you will be 70 at the end of the year that you turn 70 ½ or divide that number by 26.5 if you will turn 71 at the end of the year that you turn 70 ½.
In the examples above, Fred would use 27.4 as his divisor and Wilma would use 26.5 as her divisor. The math would show you the amount of money you need to withdraw to make the IRS happy. Remember that it is your money. The IRS just wants you to withdraw it so they can tax you on it.
Like the directions on your shampoo bottle, this is a lather, rinse, repeat requirement. Meaning each year after you turn 70 ½ you will have to do this again with slightly different numbers. Thank you for joining me for this endeavor. Enjoy your spring!
*Remember if you have any concerns about this topic, please go back to Layer One.
*Remember also that there are many exceptions to this requirement that need to be reviewed. We just scratched the surface today in a topic that could be discussed in a full book.