November 29, 2013
With final holiday preparations looming, the last thing anyone wants to think about is next April's tax bill. But if you're over 70 ½ and have any tax-deferred retirement accounts (like an IRA), put down the wrapping paper and listen up: IRS rules say that, with few exceptions, you must take required minimum distributions (RMDs) from your accounts by December 31 of each year – and pay taxes on them – or face severe financial penalties.
Here's what you need to know about RMDs:
Congress devised IRAs, 401(k) plans and other tax-deferred retirement accounts to encourage people to save for their own retirement. Aside from Roth plans, people generally contribute "pretax" dollars to these accounts, which means the contributions and their investment earnings aren't taxed until withdrawn after retirement.
In exchange for allowing your account to grow tax-free for decades, Congress also decreed that minimum amounts must be withdrawn – and taxed – each year after you reach 70 ½. To ensure these rules are followed, unless you meet certain narrowly defined conditions, you'll have to pay an excess accumulation tax equal to 50 percent of the RMD you should have taken; plus you'll still have to take the distribution and pay regular income tax on it.
You can delay or avoid paying an RMD in certain cases, including:
Another way to avoid future RMDs is to convert your tax-deferred accounts into a Roth IRA. You'll still have to pay taxes on all pretax contributions and earnings that have accrued; and, if you're over age 70 ½, you must first take your minimum distribution (and pay taxes on it) before the conversion can take place.
Ordinarily, RMDs must be taken by December 31 to avoid the excess accumulation tax. However, if it's your first distribution you may wait until April 1 the year after turning 70 ½ – although you're still must take a second distribution by December 31 that same year.
Generally, you must calculate an RMD for each IRA or other tax-deferred retirement account you own by dividing its balance at the end of the previous year by a life expectancy factor found in one of the three tables in Appendix C of IRS Publication 590:
Although you must calculate the RMD separately for each IRA you own, you may withdraw the combined amount of all RMDs from one or more of them. The same goes for owners of 403(b) accounts. However, RMDs required from other types of retirement plans must be taken separately from each account.
To learn more about RMDs, read IRS Publication 590 at www.irs.gov.
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