September 8, 2016 in Retirement

7 tips about required minimum distributions for baby boomers turning 70

This year the oldest boomers — those born in 1946 — will turn 70 ½ and face taking required minimum distributions, or RMDs, from their retirement plans. These plans include 401(k)s, 403(b)s, 457s and IRAs or IRA-based plans such as SEP IRAs and SIMPLE IRAs. You fall into this category if you turned 70 between Jan. 1 and June 30 of 2016. If your birthday is July 1 or later, you’ll owe your first RMD in 2017.

For RMD novices taking the hit this year, here are some things you should know.

For a lot of people, RMDs are relatively painless because they are pulling out money from savings that they need and paying the required taxes. But even if you think you are complying with the RMD rules automatically, it is wise to figure out the requirements using the IRS RMD tables to protect yourself from the ire of the IRS. Choose the correct table based on your situation:

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The IRS levies a harsh penalty on people who get it wrong.

If you fail to withdraw the full amount of the RMD or you miss the deadline, the IRS will tax the amount you failed to withdraw by 50%.

If you have $1 million in your IRA, the IRS says that in the first year, you must take out $36,496 and pay taxes on it. If you fail to do that, you’ll owe a 50% penalty to the tune of $18,248. Ugh!

What if you fell ill and overlooked the deadline or otherwise just inadvertently screwed up? The IRS will cut you a break and waive the penalty as long as you can establish that the error was “reasonable” and you are taking steps to fix the problem. To qualify for relief, you must file Form 5329 and attach a letter of explanation.

You must take your first RMD for the year in which you turn age 70½, but the first distribution and tax payment can be delayed until April 1 of the year following the year in which you turn 70 ½. For all subsequent years, you must take the RMD by Dec. 31.

Yes, this gives you a little wiggle room, but if you delay taking your first RMD until next year, you’ll owe 2 RMDs in a single year, warns Tom Hamlin, founder and CEO of Somerset Wealth Strategies. He points out that may not be all bad, especially if you have a year when your taxes are going to be low. For instance, you retired this year and you are taking it easy. You aren’t earning income, and you haven’t yet claimed Social Security. In that case, you might owe very little in taxes, and even 2 RMDs in the same year won’t cause you to owe the IRS an exorbitant amount.

But be careful. Before you decide when to withdraw the RMD, figure out your tax bracket — or get your tax adviser to do it. If taking 2 RMDs in the same year is going to drive your income above $75,300 (assuming you’re married and filing jointly), it is going to push you from the 15% tax bracket to the 25% bracket. “That is a 67% tax increase — a quantum leap,” Hamlin says.

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If you don’t want or need to spend the money from your tax-advantaged account right away, one good way to reduce the tax bite is to take the money out of your IRA before you turn 70 ½.

You can do this in a variety of ways:

A qualified longevity annuity contract, or QLAC, is an IRS-approved annuity bought within your IRA that allows you to delay payment of RMDs on that portion until no later than age 85. The purchase amount is limited to 25% of your IRA, up to a maximum of $125,000.

“You spread taxation over time,” Hamlin says. “You put it off until tomorrow instead of dealing with it today.”

There are pros and cons. If you think you are going to spend up all your money before you reach 85, then this may not be a tax problem for you at all. But if you plan to slide into your final years with plenty of money still left in your tax-advantaged accounts, adding the income from a QLAC could leave you owing what Hamlin describes as “a massive tax payment.”

The bottom line: Do your homework before you buy.

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Instead of withdrawing your RMD, you can send up to $100,000 directly to your favorite charity.

If your estate is worth more than a certain threshold ($10.9 million for a married couple; $5.45 million for single folks), it pays to adopt this strategy because you can transfer money during your lifetime that won’t be subject to estate taxes. Plus you won’t pay income taxes if you do a direct contribution this way.

“By making a qualified charitable distribution, or QCD, equal to your RMD or up to the $100,000 cap, the rollover removes the amount given directly to charity from tax consideration,” says Kay Bell, tax editor at Bankrate. “You’ve never received the RMD money. The charity did. So you don’t owe tax on that amount.”

But if you take the RMD money out yourself and then give it to the charity, she says, “Yes, you get a deduction, but you owe the tax on the RMD amount you received.

“No tax at all on the RMD via a direct QCD is much better than a deduction on taxable income,” says Bell.