What are RMDs, and how do they affect your retirement? David gets you up to speed on the essentials, so you don’t make crucial mistakes that could affect you as you near retirement.
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[2:18] – What Are RMDs?
- RMDs stand for Required Minimum Distributions, but what are they? Like many things involving retirement accounts, they have to do with good ole Uncle Sam. For the sake of easy math, let’s say you earn $100,000 a year, and each year you put $10,000 in your 401(k). Well, the IRS only gets to tax you on $90,000. This means, over the course of 20 years, the IRS is missing out on $200,000 in revenue. Of course, this doesn’t include the gains you get on that money as it’s invested either. As a result, the IRS wants to be sure they get theirs, so when you turn 70 1/2, they require you to start withdrawing a minimum amount from your retirement accounts. When you take that money out, they tax every penny, and the money you withdraw is referred to as your required minimum distribution.
[4:24]- What Happens If You Don’t Take Your RMDs?
- If you don’t take your RMDs, the IRS will hit you with a pretty hefty penalty. In fact, they’ll charge you 50 percent of the amount you were supposed to take out. As an example, let’s say you were supposed to withdraw $10,000. You’d have to pay a $5,000, and you’d still have to pay the taxes on the entire $10,000. By the time you were to do that, you’d probably only be left with a few thousand dollars out of that initial $10,000. Don’t be trite when it comes to RMDs. The IRS is serious, and you need to plan for those withdrawals as you age.
[6:55] -What Do You Do If You Don’t Need Your RMDs?
- If you’re already planning on having a substantial income in retirement, you probably won’t need the income from your RMDs. However, you can’t reinvest the money in an IRA. You either have to put it into something that’s a taxable investment or a tax-free investment. We actually had one client who had to withdraw more than $100,000 each year as their required minimum distribution. He and his wife already had a pension, and they were both taking Social Security. They didn’t really need the income. We decided to take $10,000 of that money and invest it into a permanent life insurance policy. It was a tax-free solution with a level premium that never went up as they aged. This policy didn’t accumulate any cash value either. It was all about creating a large death benefit, and while they wouldn’t see any of it, their grandkids would get a sizable tax-free inheritance. As for the rest of the $100,000 we put it into taxable investments that would create income as they produced dividends.