Roughly 10,000 baby boomers turn 70 each day. That means they soon will have to take a required minimum distribution from their traditional IRAs and 401(k) plans.
The stakes are high for getting RMDs right.
If you don't make the appropriate withdrawals, you may have to pay a 50 percent tax on the amount that was not taken out as required. Generally, you have to start taking withdrawals from your traditional IRA, SIMPLE IRA, SEP IRA or retirement plan accounts when you reach age 70½. If you are still working, some 401(k) plans allow you to defer RMDs from those plans until you retire.
The prospect of tax reform can change the withdrawal calculation for many retirees. If you believe that Congress will cut taxes by next year, people who turn 70½ can defer their first required minimum distribution to 2018 when income tax rates could be lower, said Nick Jovanovich, a certified public accountant and partner at law firm Berger Singerman in Fort Lauderdale, Florida.
To be sure, this is a gamble. If you defer your first RMD until next year, you are required to make two withdrawals from your retirement accounts, one by April 1, 2018, and another by Dec. 31. That double-whammy could push you into a higher tax bracket. "Go see your accountant and crunch numbers," Jovanovich said.
Most advisors warn their clients not to count on changes to tax code before they are enacted. President Donald Trump and Republican lawmakers have proposed reducing the current seven tax brackets to three , but the Trump administration has not spelled out in its proposals where each bracket would begin and end.
"The way this administration is going, one has no idea when or if these changes will take place. Work with what you know," said Jon Ten Haagen, a certified financial planner and founder of the Ten Haagen Financial Group in Huntington, New York.
Many retirees may not have the option to defer withdrawals from their retirement accounts. "Most people need the income anyway, so it becomes a need for 2017 rather than a choice," said Scot Stark, a CFP and owner of Stark Strategic Capital Management in Freeland, Maryland.
How to determine your RMD
You can calculate your RMD on your own. The Internal Revenue Service uses a formula to determine the RMD for each tax-deferred retirement account you have, based on your age and account balance. The IRS provides worksheets, and the Financial Industry Regulatory Authority offers a free calculator to figure out your annual RMD. Many IRA providers, such as Vanguard, Fidelity and T. Rowe Price, will automatically calculate RMDs for account holders.
However, figuring out your overall taxable income with an RMD can get complicated when you factor in payouts from Social Security, traditional pensions and taxable investment acccounts. For wealthier people, their RMDs can increase their income and affect what they pay in monthly Medicare premiums, said Malik Lee, a CFP and associate with Henssler Financial in Kennesaw, Georgia.
"Delaying your initial RMD is not a strategy that I recommend often, but when I have, it was with a lot of hand-holding with my client and their CPA," Lee said.
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If you were to roll the dice on lower tax rates in 2018, you can still hedge your RMD bet .
A variety of transactions can limit the tax liability of an RMD:
You can donate all or part of your withdrawal without adding to your income, up to $100,000 per taxpayer, per year.
You can use up to $125,000 of an RMD to buy a qualified longevity annuity contract that generally begins at age 85.
You can buy municipal bonds that are exempt from federal income taxes. In most states, interest income received from munis within your home state are also exempt from state and local taxes.
You can contribute up to $14,000 annually ($28,000 if you're married) without triggering the federal gift tax to a 529 college savings plan for the grandkids. You can also bundle up to five years of gifts into a one-time 529 plan contribution of up to $70,000 for single filers and $140,000 for married couples.
Regardless of what happens with tax reform, it makes sense for retirees to defer their first RMD if they know they're going to be in a substantially higher tax bracket this year compared to where they will be in 2018 under existing law, Stark said.
"I think it's most prudent to work with the best available information we have today," Stark said. "Trying to predict what Congress might or might not pass is almost always a bad idea."
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