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Posted on February 1, 2019

The Top 5 Challenges Of Required Minimum Distributions

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Published by Mark Ring, Wealth Advisor

Earning a driver’s license is a classic American rite of passage for teenagers on the cusp of adulthood. On the other end of the spectrum is another rite of passage, though not nearly as exciting: required minimum distributions (RMDs).

To prevent retirement savers from being able to defer paying taxes indefinitely, the government mandates regular withdrawals from retirement accounts starting at age 70½. All retirement accounts are subject to RMDs except for Roth IRAs. (1) This secondary rite of passage is not without its challenges, and here are the top five.

1. They Are Difficult To Calculate

Required minimum distributions are not set at a flat rate, nor are they consistent over time. They have to be calculated based on the ever-changing account balance and the IRS’s prediction of the account owner’s life expectancy.

Each year you have to recalculate your RMD. Using the account balance as of December 31 of the prior year, you divide it by your life expectancy as per the published IRS tables. Since it must be recalculated yearly, it is easy for people to miscalculate or mistakenly use a previous year’s calculation. However, such mistakes can be costly. (2)

2. They Carry Heavy Penalties

The penalty for not taking the correct RMD is hefty. Whether or not the omission was intentional, any amount that you fail to withdraw for your RMD by the end of the year is subject to the same consequences.

The penalty is 50% of the amount of the RMD that was not withdrawn. That means that if you mistakenly leave $2,000 of your RMD in your account, when you do take it out, the IRS gets $1,000 and you get the other $1,000. By failing to take your RMD, you automatically forfeit half of it. (3)

3. They Can Raise Your Tax Bill

In addition to potential penalties, RMDs can also cost you in the form of higher taxes. The increased income caused by the RMD could push you into a higher tax bracket, thereby raising your tax bill. Also, a higher income could force your Social Security retirement benefits to become subject to taxation as well.

4. They Hinder Your Wealth Accumulation

If you don’t need the money from your retirement account to live on, the best thing would be to leave it there to continue growing. By forcing you to remove the money, the IRS prevents you from earning further gains on that money in a tax-advantaged way.

It is always an option to reinvest the money in a brokerage account, but then you have to pay capital gains taxes on all of the earnings. There would be no capital gains taxes if the money stayed in your retirement account. RMDs keep you from accumulating wealth the way you would if you could leave all of your money invested.

5. They Can Force You To Sell Low

RMDs are dictated by the calendar, not the market. As such, if the dates don’t line up, you could be forced to sell at a loss. The RMD deadline could easily cheat you out of the opportunity to recoup your money by riding the market back up after a drop.

You can take your RMD as monthly distributions, quarterly distributions, or a lump sum, as long as the full amount is removed from your account by December 31. (4) The problem arises when the market is down, you’re waiting for the market to turn in your favor, and the year ends before it does, forcing you to cash out your investments at a loss.

We’re Here To Help

As you can see, required minimum distributions are complicated and there is a lot that can go wrong with them. Therefore, it is always a good idea to work with an experienced financial professional when creating a strategy for your RMD withdrawals. If you have questions about RMDs or need help planning out your distributions, contact our office by calling 410-821-6724 or emailing info@jacobwilliam.com.

About Mark

Mark Ring is the Co-Founder and Managing Partner of Jacob William Advisory, a wealth management firm whose sole mission is to service their clients’ needs beyond their expectations. Mark has over 30 years of industry experience, and for the past decade, he has been committed to building Jacob William Advisory into one of the foremost wealth advisory firms. Mark graduated from the University of Maryland with a Bachelor of Science in Economics and spends his time outside of the office with his wife, Nancy, and his two wonderful children. He gives his time to numerous nonprofit organizations related to education and the arts, often serving as a board member. He enjoys playing tennis and golf, bicycling, cooking, and traveling. Learn more about Mark by connecting with him on LinkedIn.

For a comprehensive review of your personal situation, always consult with a tax or legal advisor.

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(1) https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

(2) https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#4

(3) https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#8

(4) https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds