September 02, 2018
Every week, Simply Money’s Nathan Bachrach, Ed Finke and Amy Wagner are answering your financial questions in The Cincinnati Enquirer. If you, a friend, or someone in your family has a money issue or problem, please feel free to send those questions to firstname.lastname@example.org
Richard from Loveland: I turned 70 a few months ago. What do I need to know about RMDs? How are they calculated?
Answer: RMDs, or “Required Minimum Distributions,” are the government’s way of making sure your tax-deferred money doesn’t sit in your retirement accounts (such as a traditional 401(k) or traditional IRA) forever. After all, you haven’t paid taxes on that money yet, and Uncle Sam wants his cut!
Once you reach age 70 ½, you must take your RMD from the qualifying accounts every year. However, things can be a little tricky when you take your very first RMD: you technically have until the following April 1 of the calendar year during which you turned 70 ½. In your case, since it sounds like you’ll turn 70 ½ this year, that means you officially have until April 1, 2019 to take your first RMD. But then, don’t forget, you would need to take your second RMD by the end of 2019 as well. As you can see, this scenario wouldn’t be ideal since you would essentially be getting hit twice with taxes.
Therefore, generally speaking, it makes more sense to take your very first RMD in the year in which you turn 70 ½ (even though you’re not required to do so) to help lessen the tax hit.
As for how they’re calculated, you need to reference the IRS website and its Uniform Lifetime Table. If you work with a financial advisor, he or she should be able to help you with this calculation.
Once you withdraw your money and pay the ‘ordinary income’ taxes that are due, you can use it for basically anything you want. Options include reinvesting the money, donating it (a direct transfer to charity will lower your taxable income), or saving in a 529 college plan for grandkids.
And here’s something we want to make very clear: do not forget (or ignore) RMD rules. If you fail to take your RMD in a given year, the IRS will impose a 50 percent penalty on you. For example, if you were supposed to withdrawal $20,000, but failed to do so, you would have to pay a $10,000 penalty. Ouch.
The Simply Money Point is that RMDs are a necessary evil in retirement. You might not like the fact the government is forcing you to take money from your accounts, but remember, this is the ‘deal’ you made long ago: in order to get an up-front tax break on contributions, you agreed to pay the taxes much further down the road. Now, the chickens are coming home to roost.
Tim and Claire in Finneytown: Our daughter (who is 16) earned about $2,000 this summer as a lifeguard. She told us that she wants to save the money, so where should she put it? A savings account? Stocks? Something else?
Answer: Congratulations to your daughter! We love that she’s thinking long-term and wanting to set aside the money for the future.
While a savings account or an individual stock are certainly options, they both come with downsides: currently, the average savings account is only paying about 0.08 percent per year in interest (according to BankRate.com). As for individual stocks, we believe those are too risky and can create bad habits, such as day trading.
So, what’s a better option? Look into opening her a ‘custodial’ Roth IRA through a bank or brokerage firm (‘custodial’ means the account will be in your name until she becomes a legal adult). Since your daughter is in such a low tax bracket, a Roth IRA allows her to essentially ‘lock-in’ that low rate by contributing after-tax money. The account then grows tax-free!
In a perfect world, your daughter wouldn’t touch this account until retirement (age 59 ½, technically), in which case earnings would come out tax-free and penalty-free. But, of course, life happens! So, thankfully, Roth IRAs can be pretty flexible: contributions can come out any time, tax-free and penalty-free (since taxes have already been paid on that money); earnings can be used for qualified education expenses (earnings would be taxed at her ordinary income rate, but would be penalty-free); once she’s held the account for at least five years, she can take out $10,000 in earnings to buy a first home (tax-free and penalty-free).
The current annual limit for Roth IRA contributions is $5,500, so your daughter can save her entire $2,000 this year if she wants (however, she cannot save more than her earned income amount).
Here’s The Simply Money Point: A Roth IRA can be a fantastic long-term growth tool for kids that’s tax-friendly as well.
Responses are for informational purposes only and individuals should consider whether any general recommendation in these responses are suitable for their particular circumstances based on investment objectives, financial situation and needs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing, including a tax advisor and/or attorney. Nathan Bachrach and Ed Finke and their team offer financial planning services through Simply Money Advisors, a SEC Registered Investment Advisor. Call (513) 469-7500 or email@example.com.