Does your client have an IRA account? Is your client over the age of 70½? If you answered “yes” to both questions, it’s important to help your client understand how required minimum distributions (RMDs) can affect her retirement withdrawal strategy. As a financial advisor, it’s important to be sure that your clients have all of the essential information regarding RMDs to ensure that they don’t make expensive mistakes. Below you will find some important considerations when advising about RMDs.

What are RMDs?

The RMD is the minimum amount of money the IRS requires you to withdraw from your IRA or retirement plan each year once you turn 70½. If the minimum amount is not withdrawn, you will be required to pay a 50% federal penalty tax on the difference between the amount you withdrew and the amount you were required to take.

To Whom Does It Apply?

Since IRA stands for “individual” retirement account, the IRS rules for RMDs apply to the individual only. The government requires that account holders take their first required RMD at age 70½ to prevent them from deferring the tax within their IRA forever. It’s important to also note that once you reach age 70½, the RMD applies for the remainder of your life.

How to Calculate the Minimum Distribution

To calculate how much your minimum distribution is, you must first determine the cumulative value of all of your retirement savings, then divide the sum by your life expectancy that year. Life expectancy factors can be found on the Uniform Lifetime Table provided by the IRS.

For example, the life expectancy for a person who is age 70 is 27.4. If the cumulative market value of his IRA and other retirement savings is $100,000, then his RMD for that year is $3,649.64. That number is obtained simply by dividing $100,000 by 27.4.

Key Considerations for RMDs

Compliance for RMDs may appear straightforward, however, there are several variables to consider:

  • The first consideration is that the cumulative market value of your retirement savings changes. This means the RMD must be recalculated each year as life expectancy decreases. You’ll want to make sure that you calculate the RMD correctly, because if you take out less than the required amount, you are subject to the 50% penalty tax. That’s a stiff price to pay for money that’s already yours!
  • Secondly, it’s important to note that your life expectancy never goes to zero on the Uniform Lifetime Table, nor does it decrease by one for every year of your life. Rather, it decreases by 0.9 initially, then 0.5 as you age, then 0.4. You eventually reach a life expectancy of 1.9 at age 115 and after.
  • There’s also a special rule for inherited IRAs. If you inherit an IRA from your parent before the age of 70½, you must take the RMD each year beginning when you inherited it. If your parent passed away when you were 50, that’s the year the RMD on the inherited IRA applies to you.
  • The RMD does get more complex after all the above is considered. For example, an IRA owner must calculate the RMD separately for each IRA that he or she owns, but can withdraw the total amount from one or more of the IRAs. Similarly, a 403(b) contract owner must calculate the RMD separately for each 403(b) contract that he or she owns but can take the total amount from one or more of the 403(b) contracts. RMDs required from other types of retirement plans, such as 401(k) and 457(b) plans, have to be taken separately from each of those plan accounts. Still-working exceptions for RMDs also apply but only to the 401(k) plan.

Helping Clients Decide What to Do

RMDs ensure that the government collects tax revenue on an individual’s retirement savings. You have several options when deciding what to do with your RMD. For example, you can withdraw the RMD amount and spend it, reinvest some or all of it in a taxable account, or withdraw more than the RMD amount and spend or reinvest it. What you do should be based on your own individual needs, as long as you take at least the minimum withdrawal each year.

Helping clients anderstand the ins and outs of withdrawing from their retirement account is a vital piece of retirement planning. With that being said, anyone over the age of 70½ with an IRA is advised to meet with a wealth advisor who can further assist with the RMD process.

—Check out Working Past 70½? Skip the 401(k) RMD Without Penalty on ThinkAdvisor.