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The money in your retirement savings account generally cannot stay put forever. Unless you have a Roth IRA, you are required to remove a portion of your account balance each year once you turn 72. These mandatory withdrawals are known as minimum mandatory distributions, or RMDs, and are calculated based on your savings balance and life expectancy.
Failing to receive RMDs has serious consequences – that is, a 50% penalty on any amount you do not remove. For example, if you are responsible for an RMD of $ 10,000 and only withdraw $ 6,000, you will lose 50% of the remaining $ 4,000 to the IRS, resulting in a loss of $ 2,000.
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RMDs can not only result in penalties, they can also cause tax problems. Traditional IRA and 401 (k) withdrawals are taxed as ordinary income and RMDs fall into the same category – although they are mandatory.
But the elderly have had relief in front of the RMD this year. Thanks to the CARES Act, which passed the law in late March to provide relief from the pandemic, RMDs were released for 2020. This has enabled many seniors to achieve tax savings at a difficult time. But the RMDs will be back on the table in 2021. Now is the time to prepare to avoid being caught off guard.
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Plan ahead for your RMD
For some elderly people, RMDs are not so much a nuisance as a necessity. Many older Americans rely on money from their IRAs and 401 (k) s to pay the bills and would make withdrawals even if RMDs did not exist. But if you don’t need money from your IRA or 401 (k) for maintenance expenses, then next year’s RMD can be a huge tax burden.
You may find that next year’s RMD is higher than expected. As mentioned earlier, RMDs are based on your life expectancy, as well as the amount of money you have in your retirement plan. If you don’t take an RMD this year, you could have a bigger balance in 2021, leaving you on the hook for a bigger withdrawal and more taxes. Although many retirement plans lost value in March, when the stock market plummeted, many have since recovered.
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Of course, just because the CARES Act dispensed with RMDs for 2020, does not mean that you are not allowed to take yours. Removing those funds from your retirement plan this year can ease the burden for the next year. But that benefit will be outweighed by the taxes you will pay in the 2020 withdrawal. It may not be worth it if you don’t need the money.
RMDs are irritating to those who prefer to leave their savings alone. Unfortunately, in the absence of a major health crisis, there is really no way around them. The key is to know what to expect in 2021. Factor out your withdrawal and the taxes you will be paying in your retirement budget in advance.
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