Welcome to a new year! With the holidays and celebrations behind you, it’s time to plan for the year ahead. If you have one or more retirement accounts and are over the age of 70 ½, taking your required minimum distribution (RMD) will be on the “to do” list for you and your financial advisor.
What’s an RMD and why do I have to take money out of my retirement accounts?
The biggest benefit of saving in retirement accounts is tax-free growth, meaning you never pay capital gains tax as the assets increase in value over time (motivation to start saving early!). The IRS, however, doesn’t want you and your beneficiaries to receive this benefit for eternity so, at the age of 70 ½, you must start taking money out of the account. Roth IRAs are an exception in that distributions aren’t required during the original owner’s lifetime but, after the owner’s death, beneficiaries are required to take annual distributions over the course of their lifetimes.
Many people wait until late in the year to take their RMDs in order to maximize the tax-deferred growth. There are several other factors you might consider when deciding on the timing of your RMD and it may, in fact, behoove you to take distributions throughout the year.
- End of the Year Panic
One of the biggest benefits to taking your RMD earlier in the year is avoiding the year-end logjam caused by the large quantity of donations and RMDs that are processed at this time. If your custodian is unable to process your distribution by the end of the year, you will face unnecessary hassles and fees to avoid the 50% penalty for not taking your RMD in that calendar year. Another added benefit is that you can enjoy the holidays knowing your financial “chores” are complete.
- Markets Decline
The benefit of waiting to take your RMD at the end of the year is the potential for additional tax deferred gains. However, if markets decline in any given year, you would be better off having taken your distributions early. This is a risk factor to consider after long periods of market appreciation.
If you plan to use your RMD to send a gift to your favorite non-profit organization, sending it early in the year will allow them to put your generosity to work sooner. You can feel good about supporting the organization financially as well as providing them additional time and certainty toward their annual goals.
- Rollovers and Conversions
If you wish to execute a rollover or Roth IRA conversion, you may want to take your RMD early in the year. The law states that the first withdrawal of the year is deemed to satisfy the RMD. Therefore, taking your RMD later in the year delays your ability to perform the rollover or conversion, both of which involve time to set up and process, so it’s best not to wait until the last minute.
- Consider Your Beneficiaries
Choosing to take your RMDs early in the year will decrease stress for your beneficiaries in the event of your death. During this already stressful time, it may be difficult for them to think about as they are grieving. If you die without withdrawing your RMD that year, your beneficiaries must take the same amount you would have taken in the same year, which will increase their income tax liability. And if you pass away late in the year, there may not be enough time to get the Inherited IRA set up and the RMD initiated. The process can be complicated depending upon the number of beneficiaries and the titling of the assets. Missing an RMD will result in additional paperwork and tax complications to avoid penalties. In addition to considering taking your RMDs earlier in the year, we recommend reviewing your beneficiaries with an advisor ahead of time to streamline the process at the time of death.
For many, the best option is taking a monthly withdrawal to spread out the market impact (dollar cost averaging) and avoid a year-end panic. What’s more, setting up a systematic withdrawal will allow you to check one more to-do item off your list. Certainly, every situation is different and it’s best to consult your financial advisor and plan for the New Year in advance.