Be prepared for those RMDs

You might not think that 70½ represents any particular milestone. But when you do reach this age, you will have to make some decisions that affect an important aspect of your life — your retirement income.

Here’s the background: Once you turn 70½, you will need to start taking withdrawals from your 401(k) or similar employer-sponsored retirement plan and from your traditional IRA (but not your Roth IRA). Actually, you will need to begin these withdrawals — known as “required minimum distributions” (RMDs) — by April 1 of the following year and continue taking them by December 31 each year after that. These RMDs are calculated by dividing your account balance at the end of the previous year by your life expectancy, as determined by IRS mortality tables. If your spouse is your sole beneficiary and is more than 10 years younger than you, you’d use a separate table. Don’t worry too much about the number crunching, though — your financial advisor generally can do the calculations for you.

What you should concern yourself with, however, are the first two words of RMD: “required” and “minimum.” These words mean what they say. If you don’t take withdrawals, or if you withdraw less than you should, you could face a 50 percent penalty tax on the difference between what you withdrew and what you should have withdrawn — and then you’ll still have to take out the required amount and pay taxes on the taxable portions of those withdrawals. So it’s a very good idea to take your withdrawals on time — and without “shortchanging” yourself.

Of course, you can certainly take more than the required minimum amount — but should you? The answer depends on whether you need the money. But even if you have to take larger-than-minimum withdrawals, you’ll want to be careful not to take out more than you need — because if you “over-withdraw” year after year, you run the risk of outliving your resources. That’s why it’s so important, during the early years of your retirement, to establish a sustainable withdrawal rate for your retirement accounts. Your withdrawal rate will depend on a variety of factors, such as your other sources of income — Social Security, earnings from employment, savings, etc.— your lifestyle choices, your estimated longevity, and so on. In any case, once you have arrived at an appropriate withdrawal rate, you’ll need to stick to that rate unless your circumstances change.

If you have multiple IRAs, you’ll also face another decision, because, once you’ve calculated your total RMDs for the year, from all your IRAs, you can take that amount from one or more of them. Depending on the investment mix of these individual IRAs, you may find it beneficial to take the money from one account and leave the others intact, to potentially grow further. (If you have multiple 401(k)s, though, you will likely need to calculate and withdraw the separate RMDs for each plan.)

Other issues are also involved with RMDs, so, when the time approaches, consult with your tax and financial advisors. By studying all your options before you begin taking these withdrawals, you should be able to maximize their benefits.