The first baby boomers are turning 70 this year. That means they soon will have to take a required minimum distribution from their traditional IRAs and 401(k) plans.
The stakes are high for getting RMDs right. If you don't make the appropriate withdrawals, you may have to pay a 50 percent tax on the amount that was not taken out as required.
The Internal Revenue Service uses a formula to determine the RMD for each tax-deferred retirement account you have, based on your age and account balance. The IRS provides worksheets, and the Financial Industry Regulatory Authority offers a free calculator to figure out your annual RMD.
Many IRA providers, such as Vanguard, Fidelity and T. Rowe Price, will automatically calculate RMDs for account holders and transfer that money to other savings or retirement accounts.
Generally, you have to start taking withdrawals from your traditional IRA, SIMPLE IRA, SEP IRA or retirement plan accounts when you reach age 70 ½. If you are still working, some 401(k) plans allow you to defer RMDs from those plans until you retire.
You catch a break on your first RMD, which is due in the year in which you reach age 70 ½. That means if you turn 70 ½ this year, you have until April 1, 2017, to make your first withdrawal.
However, if you defer taking your RMD in the year you reach age 70 ½ until the next year, you will need to take two RMD amounts in 2017. After your first RMD, you will have to take an RMD every year from your retirement accounts by Dec. 31.
If you have multiple IRAs, you have to calculate the RMD for each tax-deferred account and then you can take the total RMD from one account. If you have multiple retirement plans, you will have to take an RMD out from each plan, so it may benefit you to consolidate those assets into one IRA.
Inherited IRAs are a special case. You have to take an RMD for inherited IRA assets by Dec. 31 of the year after the year of the original owner's death. That's even true with inherited Roth IRAs, which don't require RMDs of their original owners.
Financial advisors recommend several strategies for helping clients minimize their RMDs:
Of course, you don't have to minimize your RMDs if you don't want to.
Using RMD guidelines works better as a withdrawal strategy for retirement accounts than the more common 4 percent rule, an old investment rubric that recommends investors take out 4 percent plus inflation adjustments from their retirement accounts each year, according to a 2012 study by the Center for Retirement Research at Boston College.
"The 4 percent rule is pretty dreadful," said Anthony Webb, the study's co-author who is now research director of the Retirement Equity Lab at the New School's Schwartz Center for Economic Policy Analysis. "For average investors, they should just follow the RMD tables and they will be OK."