The RMD is one of our favorite acronyms in the financial industry. It’s short for required minimum distribution. What is that? Required minimum distribution is for any of us who own an individual retirement account or an employer-sponsored 401K or 403B, a SIMPLE IRA, a SEP IRA…the list goes on.
Anyone who owns a retirement account, which is what we call a tax-deferred account, means you are paying pretax dollars and getting a tax deduction on the front end through your payroll system or filing tax returns each year. The IRS put into place, years ago, the regulation that when you turn age 72, the year you celebrate that birthday, you have to start taking out what we call the required minimum distribution.
Well, why should you care about that? Let me give you an example. Say perhaps you’ve done well saving. You’ve got an individual retirement account or an IRA (we like our acronyms). You’ve built up around $400,000 in this. That was the year-end value of last year. This year, in May, you turned 72. Well, the IRS regulation states that you have to start taking out a required minimum distribution from this IRA account….there are no exceptions. It is based on a simple calculation based on your age, actuarial tables that the IRS sets up, along with the market value at the end of the previous year for your account. In this instance, it’s $400,000.
If you do the math, the first year you’ll have to take out approximately 3.5%, equating to around a $14,000 distribution. Again, you might say, why is that important? Remember, this is a tax-deferred IRA account. When you take a distribution out, it is fully taxable under whatever ordinary income bracket you may be in for this tax year. That’s where we come in as a valued addition.
As your advisor, we can sit down with you before this first event occurs and help you plan out from a tax standpoint - is that required minimum distribution going to significantly affect how much you pay in taxes this year? One key to it is whether you’re still actively working and earning W2 wages or dividends from an S corporation or if you’re already retired, you may be in a low enough tax bracket where this is not going to have a big effect, but you do have to think about - I am taking this distribution, do I need to use this money for anything or maybe, perhaps, I can reinvest it into a non-retirement account.
Many of our clients choose that, if they do not need this for living income at this point. Just remember, it is an important tax consideration, whether you're working or not, and as your advisor, we can help guide you through these decisions when you do get close to that magic age of 72 when the IRS says - we need some of this back for taxes.