You Most Likely Will Face Taxes on Retirement Accounts

DownloadThis is important! Do not miss the IRS deadline on withdrawals from retirement accounts once you pass that 70th birthday, according to Money, in “Don’t Miss This Key Tax Deadline.”

The problem is, the IRS doesn’t care whether you are working or want to start taking withdrawals. It also does not care if you want that money to keep growing. The agreement you made back when you started putting money into those accounts, was that you could contribute pre-tax dollars and deferred paying income tax on that money and any earnings. However, once you turn 70½, withdrawals are necessary.

Starting the year that you turn 70½, Required Minimum Distributions or RMDs begin, and you must pay ordinary income taxes on it. The penalty is expensive: you’ll have to pay the IRS half of what you should have withdrawn, so you don’t want to miss this deadline.

A recent survey from Nationwide showed that only 13% of people who are 65 and still working, were able to identify when they will need to start taking RMDs. The RMD is a percentage of your total assets based on your age and life expectancy. Let’s look at these two general examples: say you are 70½ this year, and you have $200,000 in assets–your RMD is $7,300. If you are 76 and have the same asset value, then you owe the IRS $9,100. Your tax liability for RMDs should be calculated with the help of your estate planning attorney and your accountant.

How you take these distributions could have a big impact on your tax bill. For many people, the RMD bumps them into a higher tax bracket when they are combined with other retirement income sources. Another question to address is: how will the distribution impact your Social Security benefit?

By the time you start getting those notices in the mail, you should have an idea of what your retirement income will be and how to make the RMDs work within your budget. What is the biggest problem that people run into? They don’t know about these required distributions, or their tax liability, and are suddenly faced with a penalty on top of a tax bill. It’s not a happy surprise.

Roth accounts offer considerable flexibility, since the money you withdraw is post-tax. They are not subject to RMD rules, while the owner is living. RMD rules for Roth 401(k) accounts do apply.

The only way to completely avoid RMD taxes is to donate the RMD to a qualifying non-profit institution. This is a way to avoid taking the RMD, if you don’t need the income. You will avoid paying any taxes on it. There is a $100,000 annual limit on this generous strategy.

Another strategy if you don’t need the proceeds from the RMD: use the money to open a 529 college fund for a child or grandchild and fund that account. You’ll still have to pay taxes on the RMD, but the college savings account will grow tax free.

An estate planning attorney can advise you on an estate plan that fits your unique circumstances and could include retirement fund withdrawals.

Reference: Money (January/February 2019) “Don’t Miss This Key Tax Deadline”

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