038: Top 10 Required Minimum Distributions (RMD) Mistakes to Avoid
As we approach the end of the year, I wanted to take some time to talk about Required Minimum Distributions (RMDs). For those approaching the age of 70 ½, the government requires that you start taking out a portion of the money in your retirement accounts that you’ve been deferring for all these years.
Understanding what’s required can get complicated – and a lot of times mistakes are made. So, today I’m going to walk you through the top 10 RMD mistakes, goofs, and blunders to avoid.
#10: Rolling Over an RMD
You cannot roll over your RMD. Let’s say you have a $100,000 IRA account and your RMD is $3,800. You have to take that money out and pay taxes on it. You can do a lot of things with it – put it in your bank account, use it to travel, pay a credit card… But the one thing you can’t do is roll it back into your IRA account (or another one for that matter).
Be very careful of that, especially if you have a 401(k) plan that is requiring you to take the RMD out.
#9: Husband & Wife Combining RMDs
Another common mistake that couples make is that they think they can combine their RMDs. Nope! All your pre-tax money has to be treated as your own. For example, if a husband and wife each have a half a million dollars in their IRA accounts, and one pulls out $45,000 from their account, they couldn’t say, “Well, now I’ve covered my spouse’s IRA RMD.”
You cannot combine them. Your spouse still has to take out their required minimum distribution.
And remember, if you forget to take your required minimum distribution, not only do you have to take it when you finally realize that error, but there’s also going to be a 50% penalty.
#8: Not Taking Liquidity
A lot of do-it-yourselfers and those in real estate love to have self-directed IRAs and buy real estate properties and alternative type investments. But once you reach the age of 70 ½ you have to get your required minimum distribution out.
Let’s say you have a self-directed IRA that’s owning the real estate and that real estate is not liquid or generating any income. The IRS doesn’t care. You’re going to have to sell off something to generate liquidity to meet your RMD needs.
#7: Taking Credit for Withdrawing Excess in the Previous Year
Taking credit for withdrawing an excess in the previous year is not allowed. Just because you took double your RMD the previous year, doesn’t mean you can roll that over to the following year. For example, if your RMD was $5,000 and the previous year you took out $10,000, you cannot use what you took out on the previous year for this year’s required minimum distribution.
#6: Believing that the “still working” Exception Applies to IRAs
If you are over 70 ½ with a 401(k) and you’re a full-time employee, then you do not have to take out your required minimum distribution – as long as you’re a full-time employee during that year.
If you do retire on or before December 20th, you are going to be required to take your RMD out. So, the mistake people make is thinking that if they’re working, that the 401(k) rule also applies to IRAs. Unfortunately, it does not and it doesn’t apply to any other 401(k) plan that you have out there from existing companies that you worked for. So, it’s only for the specific company that you work for right now, as long as you’re a full-time employee.
#5: Making Traditional IRA contributions After RMDs Have Started
Once you reach the year in which you turn 70 ½, you cannot add any money to your IRA, even if you had income and prior to 70 ½ you were able to put money in. You can contribute to a Roth IRA if you have earned income. Roth IRAs have no age restrictions, only income restrictions. So, making traditional IRA contributions after RMDs have begun is an absolute no-no.
#4: Thinking Your Annual QCD is Limited by the RMD amount
The qualified charitable distribution (QCD) allows you to take a portion of your RMD and donate it directly to a charity. This allows you to cover your RMD and not have to pay taxes. But, your annual QCD is not limited by the RMD amount. You can offset your entire RMD assuming it is not more than $100,000 with a qualified charitable distribution to CD and earmark additional IRA dollars for your QCD up to $100,000. So, if your RMD is $10,000, you can direct the full amount to a charity and not have to pay any taxes on that. But, you can also go above and beyond that! If you wanted, you could give up to $100,000 from the IRA.
#3: Not Understanding the RMD Aggregation Rules
If you have multiple IRAs, you can aggregate those for your RMDs. However, you cannot satisfy an RMD from an employer plan like a 401(k) to cover your IRA. So, if you still have a 401(k) or if you have multiple 401(k)s, each of those 401(k)s have to be treated like their own island – and you will have to take out the required minimum distribution from that. Many people will roll over to an IRA because it gives them more control to take RMDs out from the IRA account that they choose.
#2: Not Taking an RMD at All
Missing an RMD is a huge mistake and will result in a 50% penalty on any part of the RMD that is not withdrawn. If you’ve made this mistake, there’s still hope! You can file an exception and many times the IRS will be lenient in making you not have to pay that 50% penalty. So, if you’ve not taken your RMD out, own up to it, take it out immediately, and then try to fill out the form with your CPA to get an exception on that big, 50% penalty.
#1: RMD Calculation Rules and Errors
The number 1 error that we see is RMD calculation rules and errors. So, using the wrong balance, the wrong life expectancy, and/or the wrong age can be disastrous. Use the December 31st balance of the year before the distribution year. So, you want to get the value of all your retirement accounts on December 31st of the previous year. And remember that the life expectancy numbers are factors, not percentages.
Below is an easy way for you to identify what the percentage is….
So, for those that are getting close to 70 ½ or older, hopefully these tips helped. Of course, if you have any questions, you can always reach out to us at any time at questions@bayntree.com.
Transcript
Click to Read Transcript[00:00:03] Andrew Rafal: Welcome back to a brand new episode of Your Wealth & Beyond. And as we get close to year-end here in 2019, I want to take some time to help those of you that are 70 ½ or older or getting close to that age and have IRA accounts, 401(k) accounts, SEP IRA accounts. But we’re going to talk today all things required minimum distribution. So, required minimum distribution, listeners, as most of you know, once you hit that age of 70 ½, the government requires that you start taking out a portion of the money that you’ve been deferring all these years. In a sense, it’s their way of saying we want to get paid some of that tax dollars that you’ve been avoiding. So, each year starting at 70 ½, you have to take out a portion of your retirement accounts. And as always, it’s not as simple as it should be. It’s complex and if you’re a do-it-yourself or even if you’re working with the team, a lot of times mistakes are made.
So, today what we’re going to go through are the top 10 RMD mistakes, goofs, blunders to help make sure that you avoid this. If you have any questions, you can always reach out to us at any time at questions@bayntree.com but let’s go through this top 10 list kind of like we’re David Letterman and the Tonight Show or The Late Late Show. My apologies there. Okay. Number 10 on the list is rolling over an RMD. So, let’s say you have a $100,000 IRA account and your RMD is going to be let’s call it $3,800, so you have to take that money out. You have to pay the taxes on it. You can do a lot of things with it, put in your bank, you can use it to travel, you can pay a credit card, but the one thing you can’t do is you can’t roll it over back to that IRA account or another IRA account.
[00:02:06] Andrew Rafal: So, be very, very careful of that, especially if you have a 401(k) plan that is requiring you to take the RMD out. You cannot take that RMD that they’re going to send you and roll it over to an IRA account. Also, in the scope of you’re going to do a full rollover what has to happen first, the 401(k) company should take the required minimum distribution out and send that to you in a check, and then have another check that’s sent to the custodian that’s paid to the order of the custodian for your benefit. So, please make sure that if you have a 401(k), you’re over 70 ½, that you follow those guidelines.
Number 9 on our list is a husband and wife combining their RMDs. So, you have to think of it even though you’re married is that each of your IRAs, 401(k)s, 457, SEP IRA. So, all your pretax money are your own. Treat them as they’re on their own island. So, that means if we have a husband and wife each with a half a million dollars in their IRA type of accounts, and one pulls out $45,000 from their account, which is obviously more than they’re going to have to take, they can’t use that $45,000 and say, “Well, I’ve covered now my wife’s IRA RMD.” You cannot combine them. She would still have to take out her required minimum distribution. So, be very careful on that in the scope of what it can do to increase the amount of taxes that you’re paying if you don’t take into account both required minimum distributions. And remember, if you forget to take your required minimum distribution, not only do you have to take it when you finally realize that error, but there’s going to be a 50% penalty. So, if your RMD was 20,000, you’re going to have to pull out another 10,000 on top of the 20.
[00:04:09] Andrew Rafal: Number 8 on our list is not taking liquidity and do an account for RMDs. Let’s say you have a self-directed IRA that’s owning the real estate and that real estate property, let’s say, it’s not liquid or not generating any income, the IRS doesn’t care. You’re going to have to sell off something to generate liquidity to meet your RMD needs. So, that’s where I know a lot of do-it-yourselfers and those in the real estate field they love to have self-directed IRAs and buy real estate properties or other exotic or alternative type investments. But one thing is it can definitely become a detriment once you reach the age of 70 ½ and beyond in regards to making sure that you’re getting your required minimum distribution out.
Number 7 on our list is taking credit for withdrawing an excess in the previous year. This is not allowed. Just because you took double your RMD the previous year doesn’t mean you can roll that over to the following year. So again, an example, if your RMD was 5,000 and the previous year you took out 10,000, you cannot by any means use what you took out on the previous year for this year’s required minimum distribution.
Alright. Number 6 on our list is thinking the-still-working exception applies to IRAs. So, here’s something that’s a little known but if you are over 70 ½, and you have a 401(k) and you’re a full-time employee and you don’t own the company, then you do not have to take out your required minimum distribution as long as you’re a full-time employee during that year.
[00:06:03] Andrew Rafal: If you do retire on December 20, you are going to be required to take your RMD out. So, the mistake people make is thinking that if they’re working that that 401(k) rule also applies to IRAs. Well, unfortunately, it does not and it doesn’t apply to any other 401(k) plan that you have out there from existing companies that you worked for. So, it’s only for the specific company that you work for right now, as long as you’re a full-time employee.
Number 5 on the list is making traditional IRA contributions after RMDs have begun. Once you reach the year in which you turn 70 ½, you cannot at least at this moment in time, they may change that rule, you cannot add any money to your IRA even if you had income and prior to 70 ½ you were able to put money in. You can contribute to a Roth IRA if you have earned income. Roth IRAs have no age restrictions, only income restrictions. So, number 5, making traditional IRA contributions after RMDs have begun is an absolute no-no.
Number 4, thinking your annual QCD is limited by the RMD amount. So, the qualified charitable distribution, we’ve done plenty of shows on this, this allows you to take a portion of your RMD and donate it directly to a charity. What that does is it allows you to cover your RMD and not have to pay taxes. But in this case, thinking your annual QCD is limited by the RMD amount, not true. You can offset your entire RMD assuming it is not more than 100,000 with a qualified charitable distribution to CD and earmark additional IRA dollars for your QCD up to 100,000. So, long end of that is if your RMD is 10,000, you can of course direct that 10,000 to a charity and not have to pay any taxes on that but you can go above and beyond that.
[00:08:09] Andrew Rafal: And if you really were inclined to give to a charity, you could give up to 100,000 from the IRA, that obviously is much more than you’re required to take out but what this does is allows you to give to a charity. So that’s important. I know it’s not going to affect many of you, but it’s important to know.
Number 3, not understanding the RMD aggregation rules. This is very important, similar as we talked about with spouses. The IRA so if you have multiple IRAs, you can aggregate those for your RMDs. However, you cannot satisfy an RMD from an employer plan like a 401(k) to cover your IRA. So, if you still have a 401(k) or if you have multiple 401(k)s, each of those 401(k)s are their own island and you will have to take out the required minimum distribution from that. Thus, why many people will roll over to an IRA because it gives them more control and it gives them more flexibility of taking RMDs out from the IRA account that they choose. So, important to know the aggregation rules, very, very important.
Number 2, not taking an RMD at all. Missing an RMD is a huge mistake and will result as we discussed earlier in a 50% penalty on any part of the RMD that is not withdrawals. So, by not knowing you have the 50% penalty waived is almost just as egregious. So, what we’ve seen in the past, if you’ve made this mistake, and you figured it out, and you took out your RMD as soon as you did or if you start working with an advisor that knows their stuff and says, “Hey, why didn’t you take that RMD out?” and you said, “I didn’t know I had to,” what you can do is file an exception and many times the IRS will be lenient in making you not have to pay that 50% penalty.
[00:10:04] Andrew Rafal: So, it’s very, very important. If you’ve not taken your RMD out, own up to it, take it out immediately, and then try to fill out the form with your CPA to get an exception on that big, big, big penalty of 50%.
And then lastly, the number 1 error that we see is RMD calculation rules and errors. So, using the wrong balance, the wrong life expectancy, and/or the wrong age can be disastrous. Use the December 31st balance of the year before the distribution year. So, you want to get the value of all your retirement accounts on December 31st of the previous year, and also remember that the life expectancy numbers are factors, not percentages. So, there’s lots of calculators out there. In the show notes, we’re going to have a very easy way for you to identify what the percentage is.
If you’re working with the financial advisor or the custodian where the money is held, they should be able to outline to you exactly what you need to pull out based on your age, based on the account balance, and we always say, especially in those first few years, they seek out a professional and an advisor to help make sure that you don’t make these mistakes. Because ultimately, by you trying to do it on your own could cost you thousands of dollars and headaches so why not work with a professional team that can help guide you in the right direction? So, it’s confusing. They never make anything easy, whether it’s the tax code, whether it’s Medicare, whether it’s social security, and now, in this case, required minimum distributions. So, listeners, those that are getting close to 70 ½ or older, hopefully, this helped. You’ll be able to see all of this in the show notes. Also, this document will be in there as well. We thank you as always and stay tuned later this month for a new episode of Your Wealth & Beyond. Happy planning, everybody.
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