July 1st, 2016 was an important milestone for the baby boomer generation – the first boomers began turning age 70 ½. Those boomers with IRA and employer retirement accounts will need to make a decision about whether to begin taking minimum distributions this tax year or defer the first distribution until April 1st of next year. An estimated 10,000 boomers will turn 70 ½ each month for the next 18 years.
Affected boomers should start planning now to minimize the tax impact of their required minimum distributions (RMD). These withdrawals can push retirees into a higher tax bracket. Ideally, anyone with sizable retirement accounts should be planning way ahead of age 70 ½ to control RMDs well before they must begin taking them. Here are some quick rules to keep in mind:
- Withdrawals from tax-deferred retirement savings accounts can be taken without penalty starting at age 59½.
- RMDs from IRA, 401(k) and other employer sponsored plans must begin by April 1st of the year after reaching age 70½. Thereafter, the RMD deadline is December 31st every year.
- Those who are still working and participating in their employer’s 401(k) plan, may be able to defer RMDs from that account. However, they must still take them from any IRAs.
- RMD amounts are calculated using an IRS formula that is based on life expectancy. The table can be found here.
- Penalties for not taking RMDs are steep. The IRS levies a 50% penalty on the amount you didn’t withdraw.
RMDs can have a significant impact on a retiree’s tax liability. Social Security benefits are taxed based on other taxable income. RMDs could make benefits taxable resulting in a higher effective tax rate for the taxpayer. If you don’t need the money and you are charitable, consider making your charitable gifts each year with your RMD. This not only saves the tax on the gift, it keeps the amount donated off the front of your tax return potentially reducing or eliminating Social Security taxation.