Following World War II, many young men returned home to their fiancée’s and wives and, well, the “Baby Boom” era was born. A baby boomer is a term referring to a person born between 1946 and 1964. During the boom, almost 77 million babies were born in the United States alone. The “Baby Boomers” now make up nearly 20% of the American public. In 2016, the first of the boomers, those born in the first half of 1946, will reach age 70 ½. This is an important age for Baby Boomers who have an IRA or 401k.
Here’s a little history lesson. The first piece of tax legislation to change the tax code to allow for tax deductible contributions to an IRA was in 1974. This allowed individuals who weren’t covered by an employer sponsored retirement plan to make deductible contributions to an IRA. Then in 1981, Ronald Reagan signed into law the Economic Recovery Act which allowed all workers, regardless of their employers’ retirement plans, to contribute and deduct up to $2,000 to an IRA. This didn’t last long and five years later the 1986 Tax reform Act was passed that placed limits on high-income workers who were also covered by employer plans.
The federal government does not want IRA and similar qualified retirement accounts to defer taxation indefinitely so tax law states that retirement accounts holders must begin taking minimum withdrawals once they reach the age 70 ½. And this is where our baby boomers come in. Happy Birthday to all those boomers born in 1946; you are now 70 years old.
So here’s what you need to know if you were born in 1946 and you have funds in an employer-sponsored retirement plan or an IRA and you are now required to take an RMD aka Required Minimum Distribution. Make sure and add RMD to your retirement vocabulary if you haven’t already done so.
Question: If I am turning 70 ½ in 2016, when do I need to take my first Required Minimum Distribution on my IRA?
Answer: If you turn 70 between January 1st and June 30th, 2016, you must take your first RMD by April 1, 2017.
If your 70th birthday is from July 1through December 31st, 2016, then you are able to wait until April 1st of 2018.
Important!!! The first year, and only the first year, RMD’s can be taken as late as April 1, of the year after you turn 70 ½. All subsequent years must be taken by December 31st to avoid penalties.
This is where things get tricky. Remember, if you delay your first RMD until April 1, 2017, you will end up with two distributions in the same year. Your next RMD will be due by December 31st of 2017.
If you turn 70 ½ in the latter part of 2016 and stave off your first RMD to April of 2018, again you will have two distributions in one year.
This is considered taxable income so if you are receiving social security benefits, a portion of your social security may now become taxable as well, if your taxable income is over a certain threshold. This is where good tax planning is essential. You may want to go ahead and take the first RMD in 2016 in order to break up the double RMD income.
Question: Does the same RMD rule apply to 401k plans?
Answer: 401k plans require RMD’s to be taken at 70 1/2, but with some differences.
If you are still working, you are not required to take RMD’s from your 401k plan until the year you retire. The exception is if you are a 5% or more owner of the business that sponsors the plan, in which case you cannot delay RMD’s past 70 1/2.
Question: What is the penalty if I fail to make my RMD withdrawal on time or if I don’t withdraw enough?
Answer: The IRS imposes a stiff penalty of 50% of whatever you should have taken out, but did not take.
Most people who fail to take the full RMD say that it is completely unintentional, but there is no consideration for accidents or miscalculations. It is a 50% penalty, no matter what the intent. Do not wait for your plan administrator to contact you about your RMD. Call as soon as you turn 70 to start the process of planning for the RMD.
Question: I have multiple IRAs and a 401k, do I need to take RMDs from each?
Answer: No, you can add up the total RMDs from all retirement plans and take them from one or more IRAs or 401ks.
From an investment planning standpoint, you may not want to be forced to liquidate certain investments in a particular plan. Being able to aggregate the RMDs and choose which plan to withdraw from can help ensure you are managing your investments in an optimal manner.
It is best to contact a tax professional who can prepare a tax planning session based on several scenarios or when you take that first RMD.