If you haven’t started thinking about taxes, you’re behind the curve.
And there’s one tax item that sneaks up on many of us. It can cost a bundle if you don’t handle it properly.
I’m talking about the required minimum distribution (RMD) from tax-deferred accounts like IRAs.
At a glance, it may not look like much, but it can turn into a big number.
How? Well, there’s a penalty for failure to withdraw. The penalty amount is 50% of the required distribution you didn’t take.
If you fail to withdraw for even just a few years, the penalty amounts can really add up. And the penalties are on top of any past-due distributions you’d be obligated to take!
RMDs kick in when you turn 70 1/2, and during the year, the RMD percentage for your IRA is 3.65%.
By the time you’re 75, it’s 4.37%, and at 80, it’s 5.35%.
Remember, these are percentages of your account balance at the specified time.
For example, if you had $500,000 in a deferred account, you’d have to withdraw $18,250 at 70 1/2. If you’re dealing with multimillion-dollar accounts, the amount would be much larger, so you could really have a problem.
Now, on the surface, these amounts (for most of us) aren’t earth-shattering in and of themselves.
But if you don’t plan for them, and they bump you into a higher tax bracket, it could cost you big-time. RMD withdrawals are taxed as ordinary income, so a higher tax bracket means you could end up owing Uncle Sam more than you planned for.
When you consider how many of us are working in retirement (and therefore have additional income to consider at tax time), adding RMDs to the equation makes a big tax problem. Especially for folks who are unprepared.
The best solution is to strategize ahead of time. Figure out where your income puts you in the tax brackets, and distribute as much as you can before 70 1/2. Take your distributions when you plan to have the lowest tax liability.
This way, when you turn 70 1/2, and you have to take money out, the required distribution and taxes are calculated on your smaller account balance.
At the very least, a year before you turn 70 1/2, start looking at how much you’ll have to take out and how it’ll affect your taxes. Give yourself time to deal with it.
In almost all cases, you’ll have to pay taxes on your money. One way or another, Uncle Sam will get his share.
But it should never be a surprise. If you handle it properly, you can limit and control what you owe and when.
Don’t let the RMD sneak up and bite you on the butt. It can be a bigger and costlier issue than you might think.
If you’re retired or planning for retirement, and you hold tax-deferred accounts, get on the phone with your tax preparer and find out where you stand.