Penalty For Not Taking Required Minimum Distribution (RMD)

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What is so great about investing in an IRA or employer retirement plan?  Tax deferral.  You put money into the account and it grows, tax deferred, for many years.  What does “tax deferred” mean?  It means that the money is growing but you are not paying taxes on those earnings… yet.  You have heard the saying “It takes money to make money.”  The idea is that you can keep your money and use it to grow your portfolio, and later, when you take the money out of the account to use it, that is when you will pay the taxes.  You “defer” the taxes until later.

Can I defer the taxes forever?

No.  Uncle Sam thought he was being nice enough to let you defer the taxes, but he does want to get his hands on those taxes at some point.  That is why there is a Required Minimum Distribution (RMD) starting at 70.5 years of age.  Most people start taking money out before that, because they were saving their money for retirement after all.  Even if you are taking money out of your IRAs, and other qualified accounts, make sure that you are taking at least the RMD, because there is a stiff penalty if you are not taking your Required Minimum Distribution or if you are not taking as much as you are supposed to take.

Required Minimum Distribution Penalty

The penalty for not taking your Required Minimum Distribution is 50% of the amount not taken or of the shortfall.  Yes, you read that right, 50%.  It is very important to take your RMD each year.

What if I made an honest mistake?

If, after the fact, you find that you have not taken your RMD and you correct the situation.  Or you didn’t take enough, and you correct the situation, the IRS has a process for asking for the penalty to be waived, as long as it was “due to a reasonable error”, according to the IRS website.  Keep in mind that does not mean that it will be waived.  You can find information on www.irs.gov  you will be filling out Form 5329 to try to qualify for the waiver, this is an instance where you might consider consulting a tax advisor.

Required Minimum Distribution (RMD) blog post series

Required Minimum Distributions generate many questions so I am creating a series of blog posts to address these questions:

 

Employer Retirement Accounts: 2013 Contribution Limits

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An excellent way to save

What is my favorite feature of investing in your retirement plan at work?  No, it’s not the employer match, well alright it is the match, but a very close second is the fact that it is automatic!

The Elephant

Because companies are doing away with pension plans, saving for retirement can seem like an impossibly huge task.  But as the old saying goes “How do you eat an elephant? One bite at a time.”  Having a little money taken out of each paycheck and deposited automatically into an employer sponsored retirement account is taking that one bite at a time.  Eventually you will get that Retirement Elephant eaten.

Change in contribution limits

Each year the IRS announces if there are changes in the maximum contribution limits to employer plans due to cost-of-living increases.  Why is that important to you?  Because you can take bigger bites; and get that Retirement Elephant eaten sooner.  The catch is, depending on the instructions you set up for 2012, you may need to take action and contact your Human Resources department to let them know that you want to increase the amount you are investing in your retirement plan.  This is the month that HR usually wants to hear from you about these decisions, so the timing is right.

401(k), 403(b), 457, and SARSEPs

The 2013 maximum contribution limit is $17,500, an increase of $500 over 2012.  Be sure to contact your company to take advantage of the opportunity to put more money into your plan next year!  If you are 50 or turning 50 in 2013 you have the opportunity to add additional money to your employer sponsored retirement plan each year in the form of a Catch-up Contribution, the amount for 2013 is $5,500 the same amount as last year.  However, please check to make sure you are taking advantage of this opportunity; it is common for me to find that new clients are not doing this, and have often never even heard of a Catch-up Contribution.  But now you have, and you can take full advantage of it!

SIMPLE plan

The maximum contribution limit also went up for the SIMPLE, it will be $12,000 in 2013 whereas it was $11,500 in 2012.  If you are 50 or turning 50 in 2013 the Catch-up Contribution for SIMPLEs in 2013 will be unchanged at $2,500.

What to do

Check to see what you are contributing to your employer sponsored retirement plan, if you want to “put the max in” as I so often hear, make sure that you do that by adjusting the numbers for the new 2013 increases.

If you are over 50 or will turn 50 in 2013, make sure that you take advantage of the Catch-up Contribution which allows you to put additional money in the account.

If you are not “putting in the max” make sure that you are getting at least the full amount of the match from your company.  This needs to be balanced with having an emergency fund/savings account.

Once you have gotten to the point of getting all of the match, and establishing the appropriate emergency fund for your family, you need to evaluate all your goals and make sure that you deploy any extra cash among those goals in a way that fits with your priorities and values.

A hint for increasing your retirement savings – each time you get a raise, increase your retirement account contribution by one percent.  You will not even feel the loss, because it is money you didn’t even have yet.

Take action today, and you will be that much closer to retirement!

Social Security Cost of Living Adjustment for 2013

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If you receive monthly Social Security and Supplemental Security Income benefits your benefits will increase 1.7% beginning in January 2013.

Cost of Living Adjustment

The cost of living adjustment (COLA) is made annually.  Sometimes there is no increase as we saw in 2010 and 2011, and sometimes it is as high as 14.3% which we saw in the 1980’s during the high inflation years.  The COLA for 2012 was 3.6%.

No More Paper Checks

Another change for 2013, for those receiving Social Security benefits, is that paper checks are being phased out by March 1, 2013.  In my first job out of college I worked at a bank, while I did not work in the lobby, I walked past the lobby to get to the elevators on the way to my office.  I remember that the lobby was always packed on the third day of the month, because Social Security checks were hitting mailboxes and customers would bringing them in to deposit them.  That was many years ago, I’m sure that isn’t the case anymore.  However, the estimate is that the government is going to save $120 million dollars per year when they stop mailing paper checks. So there are many people that still get paper checks, and there will be a cost savings to moving people to direct deposit.  If you get paper checks, be aware that you must sign up for direct deposit very soon.

Maximum Earnings Subject to Social Security Tax

For those of you still working, the maximum amount of earnings subject to the Social Security tax has been increased from $110,100 to $113,700.

Modern Portfolio Theory revisited

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Yesterday morning I attended the St. Louis Chapter of the Financial Planning Association meeting to hear a presentation titled “Modern Portfolio Theory 2.0.”  It was excellent, no surprise, because it was presented by Michael Kitces  MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL whom I often describe as a “walking brain” when discussing him with peers.  He is also the author of a reference book I own, and to which I often refer.

Michael came in from the Washington DC area to share his research on market and economic history, the accompanying signals and data, and what it has told us about subsequent market performance.  He also had ideas for how this information could be layered on top of Modern Portfolio Theory in a tactical way to mitigate some risk in client portfolios.

Modern Portfolio Theory

In the 1950’s, Dr. Harry Markowitz pioneered the idea of considering your investment portfolio as a whole unit, rather than as individual securities, when measuring risk and expected return.   He determined mathematically, that you could put investments in the portfolio that had a bit more risk (more volatility) and yet create less volatility in the portfolio as a whole.

This reduction in volatility was accomplished by having investments that were not completely correlated, meaning they did not move in tandem.  So when one investment zigs another one zags.  In effect, when you have multiple investments moving in different amounts of up and down directions at different times, it creates a smoother path overall.

There are different steps involved in implementing Modern Portfolio Theory.  I gave a “plain English” version of the Asset Allocation step in my blog post “Peter Cottontail Makes A Lousy Investment Advisor!” which explains the reasons for diversification and rebalancing a portfolio.

Modern Portfolio 2.0

In his presentation Michael pointed out three factors that make following Modern Portfolio Theory, without any adjustment, challenging.

  1. Returns – they seem to vary for an extended period of time
  2. Standard Deviation – there are distinct high and low volatility periods
  3. Correlations – became close to 1 during the recent crisis

He shared with us different valuation data points, macroeconomic information, and technical trend analysis information to evaluate when considering adjustments to Modern Portfolio Theory inputs.

I have seen Michael speak on similar topics and can see that his research is expanding, he shared more data points and ideas for implementation than in the past.  I look forward to seeing where the research leads.

What is an RMD: Required Minimum Distribution?

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Sometimes Uncle Sam can be a really nice guy.  He lets you save money in tax deferred accounts such as IRAs, 401(k)s and the like.  You get to watch that money grow over the years, accumulating in value, while not paying any taxes on the gain.  Uncle Sam just waits patiently on the sidelines not collecting taxes on the earnings.  However, Uncle Sam isn’t going to wait forever, and that is where the Required Minimum Distribution comes in.

What is a Required Minimum Distribution (RMD)?

What if you never had to tap into your IRA?  What if you had enough money from pensions and in taxable accounts so that you could just let your IRA sit, unused forever?  Well then, Uncle Sam would never get his tax money would he?  He has been a nice guy up to this point, but he has his limits, he wants to see some tax revenue, and he has decided that when you turn 70.5 is as late as he is willing to wait to start to see it.

When– Once you turn 70.5 you will be required to take money out of your IRA.  The fact is many people will have already been taking money out of their IRA, and probably paying taxes and the earnings, but if you have not, you must at 70.5.   For more details I will be writing a blog post entitled “When do I have to take my RMD?”

How much – It is the minimum amount that Uncle Sam says you must take out of your tax deferred accounts (IRAs, 401(k)s and the like) each year.  The figure is based on the value of your tax deferred accounts on the last day of the year and calculated based on your life expectancy.  For more details on I will be writing a blog post entitled “How much will the Required Minimum Distribution (RMD) be?”

Why – So Uncle Sam can finally get his hands on the tax revenue which has been deferred all these years.

IRA money is for your retirement income

You are investing money in your IRAs and 401(k)s for a reason, to use during your retirement years.  For many families, they will be taking enough money out of their account each year to cover their living expenses anyway, more than the amount that they need to take out for the Required Minimum Distribution.  Especially as we see fewer and fewer pensions.   However, it is good to know the details because the penalty for not taking your Required Minimum Distribution (RMD) is quite steep.  It is 50% of the RMD amount that should have been taken but was not.

Required Minimum Distribution (RMD) blog post series

Required Minimum Distributions generate many questions so I am creating a series of blog posts to address these questions: