Most people are aware that they will be required to take money out of their qualified accounts when they get older. But as with anything in life, the timing is what matters. Do you just start blindly taking withdrawals when you hit 701/2? Retirees will be better served by a strategy that identifies exactly when distributions will be required.
Before you even approach the idea of clicking that withdraw button, the first question to consider is which accounts require Required Minimum Distributions (otherwise known as RMDs)?
Distributions are required to be taken from qualified accounts such as IRAs, TSP, 403(b)s, 457 plans among others when the owner of the account reaches age 701/2.
Exactly how do RMDs work?
Your first RMD must be taken by April 1st the year after you turn 701/2. If you are still working at age 701/2 then you may not be required to take RMDs from your TSP until April 1st of the year after you retire. Once you collect your first RMD, all subsequent distributions have to be taken by December 31st of that year.
What if I’m late taking my RMD?
If you are late taking your RMD you will be assessed a penalty of 50% of the RMD amount. For example, if your RMD was 10k, you will have a penalty of 5k.
Don’t be late!
What if you don’t need the money from your required distributions?
For those of you that are still working, this is a question you should address right now. The earlier you plan for future distributions, the more control you will have in the future.
If you are already there or really close to taking RMDs you have a few options.
- Gift the money to a charity. The IRS allows you to gift your RMD to charity and get a full tax deduction. The benefit of gifting RMDs is that you don’t pay taxes on them which may enable you to gift more than you would otherwise.
- Many retirees won’t be able to deduct their charitable contributions in 2019 due to the changes in the tax law. However, gifting your RMD to a charity is a way to get tax benefits with your charitable deductions.
- Pay the taxes on your RMD and reinvest the money in an individual account. While this doesn’t do anything to alleviate your current tax bill, it does help keep your money invested once the RMD is taken and taxes are paid.
The way the current tax law is written, if you are in the 12% tax bracket then your capital gains rate is 0%. What that means is that you would pay no taxes on qualified dividends and long-term capital gains. Another benefit is that your beneficiaries would receive a step up in basis when investments are passed on to them. For example, you started with $50,000 of a mutual fund that grew to $150,000 at your death, your beneficiaries’ basis would step up to $150,000 and they wouldn’t owe any income tax.
Perform a Roth conversion. Conversions aren’t necessarily a fix to a person’s current tax or RMD issues, but rather a fix for future tax issues. A Roth conversion must be made in excess of what a person’s RMD is for the year. In other words, you are not allowed to do a Roth conversion on an RMD.
If a retiree’s RMD is $15,000 for 2018, then the 15k must be taken out of the qualified account. Once the RMD is satisfied any additional amount could be converted to a Roth IRA.
Conversions can provide benefits in the future and need to carefully be considered to determine if and when the right time is to do one
RMDs are required from TSP
This is something all federal employees need to be aware of. An RMD must be taken each year from your TSP regardless of how much you take out of IRAs.
The reason this is important is that with IRAs you are allowed to take a distribution from one account to satisfy the RMD for other accounts. Here is an example.
John has 3 IRAs, one with $50,000, another with $150,000 and another with $60,000. He also has a TSP with $500,000. If John’s total RMD amount from the IRAs is $10,000, then he can take the entire amount from one of the IRAs or any combination as long as the total withdrawn is equal to or above the 10k. His RMD from TSP is completely separate and must be taken from the TSP.
RMDs are required from Roth TSP
This may come as a shock to many feds, but RMDs are required from Roth TSP as well. If you don’t want to take distributions from Roth TSP then there is an easy fix – transfer out of TSP to a Roth IRA. Currently, you aren’t allowed to only transfer the Roth portion, but TSP has said this will be included in the coming changes that are being made by the end of 2019.
Required minimum distributions are just another component of a retirement plan. It pays to have a retirement distribution plan. If you would like help putting your retirement plan together, you are in luck because that is exactly what we do. Schedule a call with Brad to learn more about working with us.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.