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windfall article feature image-man looking at large piggybank

Here’s what happens when you turn 70: You blow out some candles, eat some cake, and celebrate 25,567 days of life on this planet. And that’s all good.

But in the year you turn 70 ½, if you’re one of the millions of Americans who have enjoyed the benefits of tax-deferred investing in traditional IRA, 401(k) or similar retirement savings accounts, your tax situation will suddenly change.

That’s when most holders of traditional IRA, 401(k), 403(b), 457(b), SEP, SIMPLE, and profit sharing plans must begin withdrawing “required minimum distributions” from their accounts – and paying taxes on the distributions at their ordinary income tax rate.

Required minimum distributions (RMDs) are the mandatory withdrawals the IRS requires you to take from your retirement accounts by April 1 following the year you reach age 70 1/2 and annually thereafter.

Exceptions

Roth IRAs. There is no minimum distribution requirement for Roth IRAs regardless of the account holder’s age, until after the death of the owner. Furthermore, if you’ve had the account for at least five years, all of the distributions that you do take from a Roth IRA would normally be tax-free. By contrast, Roth 401(k) account holders are generally required to begin taking distributions at 70 ½, although they would typically not owe income taxes on qualified withdrawals. (See: Benefits of Roth IRAs Go Well Beyond Retirement)

Still working. If you’re still working into your 70s, you can continue to contribute to your 401(k) or other employer-sponsored plan, and you generally don’t have to start taking distributions from that 401(k) for as long as you continue to work. Your first distribution would be due by April 1 of the year after you retire.

However, this exception would not apply to someone who has a stake of 5% or more in the company. Nor would this exception apply to any retirement plans of former employers or to IRAs. Even if you’re still working, you would be required to begin taking distributions from your IRAs and former employer retirement plans at age 70 ½.

What to Do with Your Distributions

With potentially thousands of dollars coming your way in the years ahead, you may need a strategy to get the most from your distributions.

But before you decide on any course of action in allocating your distributions, you should consult with a tax professional to make sure you’re making the best decisions based on your specific tax situation.

If you expect to spend the money to cover retirement expenses, that’s probably an easy choice. Take the distribution, pay the taxes you owe and use the money as needed.

But if you are already receiving enough income to cover your bills through a job, Social Security or any pension or investment income, it may help to develop a strategy for making the most of your distributions.

Here are some options:

Donate it. If you donate your distribution – or a portion of it – to a qualified charity, the amount of the distribution you donate is taxable, but may qualify as a tax deduction. (See: "Donor Advised Funds" Mix Charity, Investing and Flexibility)

Make a Qualified Charitable Distribution (QCD). When you reach 70 ½, you can request up to $100,000 be sent directly to a qualified charity as a non-taxable distribution from your IRA. The QCD also counts towards your RMD for the year. (No additional charitable tax deduction may be taken.)

Create an emergency fund. If you don’t already have an emergency fund, you may wish to use some of the after-tax distribution to set one up.

Fund your Life Insurance Premiums. You may use the RMDs to fund a life insurance policy. The policy could be used to defray the tax on your retirement assets that your family will receive. Or, you could name a charity as the beneficiary of your taxable retirement accounts, and the non- taxable life insurance to your family.

Reinvest it. You may choose to invest your after-tax distribution in a mutual fund or other investment in an effort to keep it growing. There are mutual funds designed to appeal to investors with a wide range of objectives. (See: Asset Allocation Funds Can Help Tame Volatility)

Start early and move some money to a Roth IRA. Even if you’re years from turning 70, it may be helpful to plan ahead.

While you are not allowed to roll over your required minimum distributions (RMD) to a Roth IRA, you may be allowed to convert the money within your retirement accounts to a Roth IRA.

Keep in mind, however, that you would be required to pay taxes at your ordinary income rate on the money you convert in the year of the conversion.

But once you’ve converted the money over to a Roth IRA, investments within the account would grow tax-deferred. If you are over age 59 ½, you can withdraw your converted money anytime, and once you’ve held your Roth IRA for at least five years, you would be able to withdraw any earnings tax free. Having a source of tax-free income could give you more flexibility in controlling your tax liability in future years. (See: The Power of Pairing a Roth IRA with Your 401(k))

You can start the conversion process well before age 70 – and you can continue the conversions until you’ve emptied your tax-deferred account – as long as you don’t roll over your required minimum distributions. (Access to converted dollars prior to age 59 ½ has restrictions.) (See: Benefits of Roth IRAs Go Well Beyond Retirement)

Once your money is in a Roth IRA, you would no longer be required to take distributions during your lifetime. One of the key things to consider is whether you can pay the taxes you will owe on the conversion from a separate source, rather than using your IRA assets to pay them. If you use IRA assets and you are under age 59 ½, you may owe the 10% early distribution tax on any funds that weren't included in the amount converted to the Roth IRA. 

Before making the decision to convert some or all of your tax-deferred account to a Roth IRA, you should carefully consider the tax consequences or speak with a tax professional to discuss the pros and cons.

To help reduce the tax impact of a conversion, you might consider spreading your conversions over several years – or waiting until you’re in a lower tax bracket in order to limit the tax burden.

But either way – whether you withdraw the money now or later when you’re required to take the annual distributions – you’re going to owe taxes at your ordinary income rate on all the money you withdraw. The decision you face is whether to take the hit sooner or later.

How much of my money must I withdraw each year?

During your lifetime, required minimum distributions (RMD) are determined through a calculation based on your age and the relationship and age of your beneficiary(ies). and the amount of money in your account as of December 31 of the prior year.

You would divide the amount in your account by the distribution period to determine your required minimum distribution.

Fortunately, you may be able to get some help from your plan administrator. The trustee, custodian, or issuer of your account must either report the amount of the distribution to you or offer to calculate it for you. Or you could use an online calculator to do the math. FINRA has an RMD calculator at its site. You can also consider setting up a systematic distribution that is taken timely each year.

Review for more information on RMDs and Life Expectancy Tables

 

The table below gives you an idea of the dollar amount of the distribution based on age and account size:

Dollar Amount of Required Minimum Distributions by Age and Account Size

(Applicable to: Unmarried Owners, Married Owners Whose Spouses Are Not More Than 10 Years Younger, and Married Owners Whose Spouses Are Not the Sole Beneficiaries of Their IRAs.)

Age

Distribution Period

RMD1 for $100,000

RMD for

$500,000

RMD for

$1 million

RMD for

$2 million

Return % to stay even2

70

27.4

$3,649.64

$18,248.18

$36,496.40

$72,992.70

3.79%

75

22.9

$4,366.81

$21,834.06

$43,668.10

$87,336.24

4.57%

80

18.7

$5,347.59

$26,737.97

$53,475.90

$106,951.87

5.65%

85

14.8

$6,756.76

$33,783.78

$67,567.60

$135,135.14

7.25%

90

11.4

$8,771.93

$43,859.65

$87,719.30

$175,438.60

9.620 %

95

8.6

$11,627.91

$58,139.53

$116,279.10

$232,558.14

13.16 %

100

6.3

$15,873.02

$79,365.08

$158,730.20

$317,460.32

18.87 %

Source: Internal Revenue Service, Publication 590-B (2016), Distributions from Individual Retirement Arrangements (IRAs)
1. RMD refers to Required Minimum Distribution
2. “Return % required to stay even” refers to the percentage investment gain you would need to earn from your remaining account balance to get back up to your estimated previous level prior to taking your distribution.
 

When must I take my distributions?

You must take your first distribution for the year you turn age 70½, although the first payment can be delayed until April 1 of the following year. After the first year, all distributions for each year must be taken by December 31 of that year. But if you postpone the first year’s distribution, that means that in the year after you turn 70½, you may have two required distribution dates – April 1 for the previous year and December 31 for the current year.

Can I make things easier by doubling my distribution one year so I can skip it the next?

Not a chance. You must recalculate the amount and take your distribution every single year.

What if I don’t take the full required distribution?

You would be subject to a stiff penalty – a 50% excise tax on the amount of the required minimum distribution that you failed to take in a particular year.
You may withdraw more than the minimum at any time, but you must not withdraw less.

What if you have more than one applicable account?

If you have more than one IRA or other employer retirement accounts, you must calculate the required distribution separately for each account. You must then withdraw an amount equal to the total of the required distributions for all of your accounts. You can withdraw the RMD for your IRAs from any of your IRAs, but you must withdraw the RMDs for any other retirement account directly from its separate account.

Where can I learn more about Required Minimum Distributions?

For further details, you can go to the IRS.GOV RMD section.

 

 

The concepts presented are intended for educational purposes only. This information should not be considered investment advice or a recommendation of any particular security, strategy, or product.

At Thrivent Mutual Funds, we recommend you consult your tax advisor to make sure you’re getting the most out of your investments. Thrivent Mutual Funds and their representatives cannot provide legal or tax advice.


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