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:
- What is a Required Minimum Distribution (RMD)?
- What is the penalty if I do not take my Required Minimum Distribution (RMD)?
- How do I calculate the Required Minimum Distribution (RMD)?
- What if my spouse is significantly older/younger than me?
- When do I have to take a Required Minimum Distribution (RMD)?
- Do I have to take the Required Minimum Distribution (RMD) from each account individually or can I take it all from one?