You’ve reached 70, and you’ve got it all figured out. You’ve finally said goodbye to having to work for income, you’re in an easy routine and everything is going well. Then you hit 70½, and the IRS requires you to start taking distributions from your retirement plan, even if you don’t need the money. The agency slaps a hefty penalty on any amount not taken. So, no matter how comfortable you feel, your 70s are not the decade to take your eye off the ball.
Required minimum distributions, or RMDs, begin in the year you turn 70½. Technically, you have until April 1 of the year following the year you turn 70½ to take your first distribution. This is the point at which the federal government no longer lets you kick the tax can down the road. Pushing your first distribution into the following year means you’ll have to take two RMDs in one year, which may have adverse tax consequences. You’ll be responsible for adding the values of your retirement accounts and dividing them by your age factor on what’s called the “uniform lifetime table.” Essentially you are required to take 3.65% of your retirement account balances as of December 31 of the previous year. Each year, that percentage will increase slightly.
As always, there are exceptions to the rules. Often, the way you take RMDs from IRAs will differ from how you take them from employer-based plans. With IRAs you are in complete control of when during the year you take your RMD. You also can choose which account you take it from, as long as the total distribution is the correct percentage for your age. With employer-based plans, you typically must choose between a monthly and annual distribution schedule. The checks come automatically. While this can help you avoid missing the deadline, it usually prevents you from controlling what you sell.
There are exceptions for those still working. If you are employed at 70½ and don’t own 5% or more of the company, you are not required to take a distribution from that
employer’s retirement account. What if you’re sitting on a beach and miss your distribution? The IRS can slap you with a heavy penalty: 50% of the amount you were supposed to take. Let’s say you have $1 million in your various IRAs. Your first RMD will be 3.65% ($36,500). If you miss that distribution, the IRS penalty will be $18,250. You read that right: $18,250. The good news is that the IRS may let you slide once. If you’re reading this a little too late, you should take the distribution, file Form 5329 and beg for forgiveness. I’d also recommend bringing on a Certified Public Accountant (CPA) for assistance. By the way, the beach may not be a good enough excuse.
How to Avoid Mistakes
Now that we have outlined a few of the mistakes you can make, let’s highlight some of the ways to avoid those mistakes. The first is consolidation. If you’re 70 years old with five traditional IRAs, it’s time to consider consolidation. Not only will this make it easier for you to figure out your RMDs, it will also make your money easier to manage. If you want to adjust your portfolio, you can do it in one shot rather than riding around town or spending all day on hold with fund companies to make sure all accounts have been adjusted. The final benefit of consolidation is more of a benefit to your heirs because the more accounts you have, the longer and, usually the more expensive, it is for your personal representatives to sort everything out.
I believe, as do most estate planning attorneys, that everyone over the age of 18 should have at least a basic estate plan. Once you have kids, it’s time to get serious with a will or trust package. Unfortunately, half of the folks I meet with (who are all 55 or older) have not adjusted their estate plan since their children were born. You should be checking with your attorney at least every five years to make sure your documents are sound. If you’ve moved to a different state, you’ll almost certainly have to have your documents redrafted by a local attorney.
Part of that estate plan is making sure your accounts are properly titled and your named beneficiaries are aligned with your goals. In order to minimize your probate estate and pass assets directly to beneficiaries at your death, you should consider trust ownership, certain types of joint ownership or Pay On Death/ Transfer On Death designations. You should update your beneficiaries annually as part of your financial plan.
Gifting, whether it be to a charity you care about or to a younger generation, can be one of the most fulfilling financial moves you make. Remember (I know you weren’t paying attention) when the flight attendant told you to secure your own oxygen mask before assisting others? The advice is the same for gifting. You must be absolutely sure that your own financial needs are taken care of before you start distribution. You can accomplish this through a financial plan. Federal law allows you to give $14,000 a year to anyone you want to without filing a gift tax return. If you’re married, you can do twice that through what’s called a split gift. Section 529 plans are a great way to help fund education, and they come with many tax advantages. Charitable giving is a great way not only to fulfill philanthropic goals but to lessen the tax sting. Have your financial planner, CPA and estate attorney work together if you have complex goals. (Full disclosure: I am a CFP.)
Now that you’ve checked your planning boxes, it’s time to start talking about them. The sad reality is that every day you come closer to your life expectancy and someone else taking over your financial affairs. Being private about your money is no longer wise. I urge you to talk to your spouse, children and anyone else who may handle your estate when your time comes. Introduce them to your planner, attorney and accountant if there is complexity. Oh yeah, and enjoy your retirement; 70 is the new 40!