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Minimum Distribution Rules: Key Things Every Retiree Should Know

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Most people worry about not having enough money for retirement. But did you also know that there can be challenges to having too much money in certain types of accounts?  Too much money may not necessarily be a bad thing, but you do need to worry about required minimum distributions (RMDs) when it comes to money in your Individual Retirement Accounts (IRAs). Here's what you need to know about RMDs.

1. RMDs Depend on Your Age

The main point of RMDs is to keep money from staying tax-free forever. The government gave a temporary tax break to encourage you to save for retirement, but it still wants that tax money. A required minimum distribution is a required withdrawal from your retirement account. It counts as ordinary taxable income, the same as wages would. 

Currently, RMDs start when you hit age 70.5 and they are calculated to empty your retirement account within your predicted life expectancy. Each year, you need to withdraw a certain percentage of your account with the percentage going up as you age. However, it's important to realize that you do not have to spend all of this money. You can also reinvest it into a taxable account.

2. Not Taking the RMD Can Mean Big Penalties

Thinking about skipping RMDs to avoid taxes? Think again. Not only do you still have to pay the taxes on the RMD amount, but you'll also owe a 50 percent penalty.

For example, if you were supposed to withdraw $10,000 but didn't, the IRS will charge you an extra $5,000. The penalty repeats every year until you catch up on your RMDs from previous years.

3. RMDs Can Throw a Wrench in Your Tax Planning

There are many reasons why you might want to reduce your taxable income in retirement. These can include qualifying for things like Medicaid subsidies, avoiding taxes on your Social Security benefits, trying to stay in a lower capital gains tax bracket, or just wanting to pay less in taxes.

Required minimum distributions can throw a major wrench in your tax planning because not only are they not avoidable, they can suddenly increase if the market surges. If you're using a tax strategy that requires reducing your income to a certain level, it's important to build in flexibility for your RMDs.

4. RMDs Can Be Avoided or Decreased

There are still ways to reduce or even avoid RMDs altogether. The main idea is to get the money out of your retirement account when you want to as opposed to when the IRS wants you to.

One method is to make extra withdrawals at the end of the year. In December, you can estimate your taxes for the year. If you still have room in a lower tax bracket or below the income you need to stay under, you can withdraw additional money. When next year's RMDs are calculated, it will be on a lower account balance.

You can also convert pre-tax money in an IRA to post-tax money in a Roth IRA.  Roth IRAs let money grow tax-free once the conversion takes place and R don't have RMDs because the money has already been taxed. When you make the conversion, you do pay ordinary income tax rates on the amount you converted, so you will want to be sure that is accounted for in your tax planning strategy.  There are no penalties even if you do the conversion before you turn 59.5.

If you are charitably inclined and do not need your RMD to live on, you can also elect to make what is called a Qualified Charitable Distribution (QCD) from your IRA.  Funds withdrawn from your IRA will go directly to a charity and you will not pay taxes on them.  However, be aware that you won't be able to count these donations towards your itemized deductions.     

Want to learn more about RMDs and how to plan your tax strategy? Talk to your financial planner today.

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.