Key Points
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Required minimum distributions, or RMDs, require careful planning.
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Missing the RMD deadline could leave you facing penalties.
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Deferring your first RMD could set off a tax bomb.
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The nice thing about saving for retirement in a traditional IRA or 401(k)is getting to contribute on a pre-tax basis. If you’re a decent earner in a higher tax bracket for much of your career, that tax break could be invaluable
On the flipside, once you turn 73 or 75, depending on your year of birth, you’ll be forced to take required minimum distributions, or RMDs, from one of these accounts. And those could create a tax headache if you aren’t careful.
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In fact, RMDs are something you’ll need to manage strategically. And that ideally means steering clear of these specific mistakes.
1. Missing the RMD deadline
RMDs are due every year by Dec. 31. While that’s an easy enough deadline to remember in theory, life has a way of getting busy late in the year, which puts you at risk of missing it.
If you don’t take your RMD on time, you risk a 25% penalty on whatever sum you fail to remove from your retirement account. So a missed $30,000 withdrawal costs you $7,500 off the bat, which is a lot of money to give up.
Obviously, if your RMD is smaller, the penalty you’re hit with might amount to less and sting less. But nobody wants to give up free money after they’ve worked hard to save it. So rather than run that risk, put your RMDs on autopilot.
Most institutions let you set up automatic RMDs on a schedule that works for you. Taking a few minutes to automate your RMDs could help you avoid handing the IRS a huge penalty check for no good reason.
2. Deferring your first RMD
While RMDs are typically due by Dec. 31 every year, you’re allowed to defer your first one to April 1 of the year after you turn 73 or 75 (whichever one is your RMD age). That might seem like a good way to put off paying taxes. But it might actually create a bigger tax bill than expected.
If you defer your first RMD, you’ll have to take two mandatory withdrawals the year after. And if those RMDs are on the larger side and you also have income like Social Security to factor in, you could end up with a very large tax bill.
Not only that, but if you’re on Medicare, a large income in any given year could subject you to surcharges on your premiums two years later known as income-related monthly adjustment amounts. So be very careful with that first RMD, and don’t assume your best move is to put it off.
RMDs can be an annoyance in retirement, to say the least. Roth conversions could help you get out of or minimize them, but they’re not always easy to pull off. So if you’re going to be stuck with RMDs, do your best to avoid the above mistakes so you can minimize your financial stress.
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