FREE NEWSLETTER
MANY SENIORS needlessly incur hefty penalties or overpay their taxes. The reason: They don’t understand the strict rules that govern removing money from their tax-deferred retirement accounts.
The IRS sets the year you turn age 70½ as the deadline to begin taking RMDs, short for required minimum distributions. (For 2020 and later years, the starting age is 72.) The feds allow some leeway for the first of your RMDs. But this is a tricky exception.
Yes, you can postpone the reckoning until April 1 of the year after you attain 70½. (No, it isn’t the April 15 due date for filing returns, as many seniors mistakenly believe.) But delaying the first RMD until the year after you turn 70½ can prove costly, as you still must take your second RMD by Dec. 31 of the same year.
Aside from the exception for the first RMD, the IRS is insistent on getting its share of at least the minimum amount each year, though you can always remove funds faster than required without incurring any penalty.
Just how expensive can indifference to the calendar be? Say you reach age 70½ before the close of 2017 and postpone the first RMD beyond April 1, 2018. The law empowers the IRS to exact a late-withdrawal penalty equal to a horrendous 50% of the difference between what should have been distributed (a set amount based on your life expectancy) and what was actually distributed. (An update: Thanks to 2022 legislation, in 2023 and subsequent years, the 50% penalty is reduced to 25% and could be as low as 10% if you rectify the mistake within two years.)
Suppose you should have withdrawn $20,000 and only remove $12,000. The $8,000 difference is subject to a 50% penalty of $4,000. Completely ignore the calendar, don’t withdraw any of the $20,000 and the penalty soars to $10,000.
The penalty’s purpose is to compel you to begin shelling out for taxes. It’s immaterial that you’re fortunate to have more than enough other income from pensions, dividends and Social Security to cover your foreseeable retirement needs and would just as soon postpone RMDs for at least several years beyond 2017, so the money continues growing tax-deferred inside your IRA.
Penalties aside, it could prove costly to delay the first RMD until early 2018 and then also have to make a second RMD later that year. Even if you make that first RMD before the April 1 deadline and thus avoid the 50% tax penalty, the boost to income for 2018 from two payouts could push you into a higher bracket and cause more to be siphoned off for taxes than if you had made your first RMD during 2017.
Moreover, because of your higher income, more of your Social Security benefits for 2018 could be lost to taxes and you might find yourself paying higher Medicare Part B and D premiums. Another drawback: Doubling up in 2018 might cause you to forfeit a valuable tax benefit. Many states authorize an exemption for a sizable part of money removed from IRAs and other retirement plans. For instance, New York exempts as much as $20,000 for each spouse. But such exemptions are on the basis of per year, not per distribution.
Julian Block wrote and practiced law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). He died in 2023. Check out the articles that Julian wrote for HumbleDollar.
Want to receive our weekly newsletter? Sign up now. How about our daily alert about the site's latest posts? Join the list.
