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THE BABY BOOM GENERATION REQUIRED MINIMUM DISTRIBUTIONS AT AGE 70 1/2
Kathleen Casey-Kirschling may not be a household name, but she holds a singular title in American history. Born just a few seconds after midnight, January 1, 1946, in Philadelphia, PA, she is known as America’s first baby boomer. About 3.4 million more babies were born that year, kicking off what would soon be known as the baby boom generation - those born in the years 1946-1964, following the end of World War II in August 1945.
Now, those first-year baby boomers are turning 70 1/2, the age the Internal Revenue Service (IRS) has set for mandatory withdrawals from tax-deferred retirement plans such as IRAs and 401(K) plans. The process of mandatory withdrawals is called "required minimum distributions", or RMDs. The RMD rule was implemented to keep account holders from letting their money grow tax-deferred, indefinitely. There has to be a payday someday and, with RMDs, Uncle Sam can count on a steady stream of tax revenue at ordinary tax rates on at least a portion of the value of the accounts.
Edward Shane, a managing director at Bank of New York Mellon Corporation, estimates that baby boomers have saved $10 trillion in various tax-deferred retirement accounts. However, with around 75 million baby boomers alive today, the average amount per person is only $133,333, which is not enough to fund 20-30 years of retirement.
RMDs are based on actuarial data and must be calculated by the taxpayer. The calculation is determined by use of one of three tables in IRS Publication 590-B (https://www.irs.gov/pub/irs-pdf/590b.pdf). Most people will use Table III, the Uniform Lifetime Table. This table is for unmarried account owners, married account owners whose spouses are not more than 10 years younger, and married owners whose spouses are not the sole beneficiaries of their IRAs. The table indicates the distribution period for each age. The distribution period is the divisor to calculate how much money should be withdrawn. For example, the table indicates a distribution period of 27.4 for age 70. Therefore, if a taxpayer has $100,000 in tax-deferred accounts on December 31, 2016 and turns 70 ½ in 2017, the taxpayer will divide $100,000 by 27.4 and withdraw the resulting amount of $3,650 by December 31, 2017. Since this withdrawal will be the taxpayer’s first RMD, he/she can defer the withdrawal until April 1, 2018.
A taxpayer can wait until April 1st of the year after he/she turns 70 ½ to withdraw his/her first RMD. However, that delay will result in two required RMDs for that year - one for the deferred year and one for the current year, which must be taken by December 31st. Caution: There is a severe penalty for not taking a RMD on time. In addition to the tax owed on the required withdrawal amount, a taxpayer will owe and extra 50% of the amount that should have been withdrawn. For example, if in the previous example the taxpayer only withdraws $2,000 of the required $3,650, the taxpayer will still owe taxes on the whole $3,650 plus an $825 penalty ($1,650 not withdrawn times 50%).
The big question with RMDs is how to maximize your income stream and minimize your tax burden at the same time. Here are some helpful strategies to accomplish that goal:
Reinvest – Resist the temptation to spend your withdrawal and reinvest it, or at least a portion, in a taxable account where it will continue to grow.
Charitable Contribution – You can have your RMD sent directly to the charity of your choice. You will receive no tax deduction for the gift, but you will owe no income tax on the amount, either. You can donate up to $100,000 of your RMD to charity without any federal income tax liability.
Purchase a QLAC – A qualified longevity annuity contract (QLAC) is a deferred annuity that you purchase inside your IRA or 401(k). A QLAC begins paying regular income at a later date, usually no later than age 85. The amount you purchase as a QLAC is removed from the total of your tax-deferred accounts before calculating your RMD in the years before the income from the QLAC begins. The amount you can purchase as a QLAC is limited to 25% of your total tax-deferred accounts or a maximum of $125,000.
Sign up for Social Security – The amount you receive in social security benefits at full retirement age is based upon your highest 35 years of earnings. Each year you delay receiving social security benefits between full retirement age and age 70 increases your total benefit by 8 percent. Per a working paper from the Center for Retirement Research at Boston College, an individual who waits until 70 to retire and sign up for social security will receive a benefit that is 76 percent higher than retiring at age 62. The Boston College paper also noted that working just until age 63 instead of age 62 replaced a zero-income year in the 35 years of earnings for 46 percent of women and 15 percent of men. [According to an October 2016 report from the Teachers Insurance and Annuity Association (TIAA), women work an average 29 years to men’s 38 because women spend an average 5.5 years out of the workforce caring for children and 1.2 years as a caregiver for an older adult.] However, despite the benefits in delaying receiving social security benefits until age 70, after age 70 there is no extra benefit in waiting to draw your first social security check.
Health Savings Account (HSA) – You may be able to make a distribution directly from your IRA to your HSA if you have an HSA-eligible high-deductible health insurance policy. It is a one-time distribution and must be less than or equal to your maximum annual HSA contribution for the year minus any contributions you’ve already made for the year. The distribution must also be made directly by the trustee of the IRA to the trustee of the HSA and you must remain enrolled in an HSA-eligible high-deductible health insurance policy for 12 months after the transfer. The distribution cannot be deducted as an HSA contribution, but you will be able to withdraw it from the HSA tax-free for medical expenses in any year. Plus, the distribution from IRA to HSA will not be included in your income, if all of the aforementioned conditions are met.
Stay on the job – If you remain employed with your current employer and don’t own more than 5 percent of the company, you are not required to make RMDs from your current employer’s 401(k) plan until you officially retire. Additionally, you can even continue to fund your current employer’s 401(k) plan. However, RMDs from IRAs and 401(k) accounts with previous employers will still be subject to RMDs. By some estimates, there could be as many as 25 percent of the 70-74 age group still in the work force in just a few years.
The baby boomers may be the first generation to re-fire rather than retire. Ms. Casey-Kirschling has helped flood victims in Illinois and Hurricane Katrina survivors. In her words, "I’m proud of how the boomers reached for the stars. We accomplished a lot and created a lot of wealth, but we need to be OK with handing off the baton to younger generations. You only have the moment. You can’t live in the past, and you don’t know what the future is going to bring."
We hope this blogpost will be helpful to any of you who are fast approaching the 70 1/2 milestone. If we can assist you with any financial concerns, please feel free to contact us at any time. May you have good health and financial security in the years that lie ahead.