CHICAGO | Mon., Mar. 26, 2012 12:55pm EDT (Reuters) - Seventy may be the new 60 — but not where the Internal Revenue Service is concerned. People who turned 70-1/2 last year must begin taking required annual withdrawals from their tax-deferred retirement accounts no later than Friday, a reality many older workers weren’t aware of. Employers can help fill the education gap.
Fidelity Investments reports that nearly half (48%) of its IRA customers who hit the magic number in 2011 hadn't yet taken their first required minimum distributions as of late December. That percentage was up slightly from 2010, when 45% hadn't taken RMDs by that time.
RMDs typically must be taken by Dec. 31 each year; except for the year in which individuals turn 70-1/2, when they have until April 1 of the next year. The effective deadline for 2011 RMD first-timers is coming up fast. Since April 1 falls on a weekend this year, account owners will have to make their annual required withdrawals by March 30.
Many seniors dislike taking RMDs, since withdrawals are taxed at ordinary income rates. But failure to comply is even more painful, slapping plan participants with a 50% penalty on whatever funds should have been withdrawn in a given year.
"Many of these folks have spent the last 40 years accumulating funds in their IRAs, and never had to start thinking about the distribution phase until now," says Ken Hevert, vice president of retirement products at Fidelity. "It's a new mindset and behavior for them."
The RMD rules apply to traditional IRAs, most 401(k)s and other qualified retirement plans. The rules don't apply to Roths, which require upfront tax payments. The RMD amounts are based on an IRS formula driven by the account owner's life expectancy; the RMD is calculated by dividing the year-end account total by the number of years you're expected to live.
Many financial services companies remind customers about RMDs through mailings and online communications, and offer online RMD calculators. Some also will calculate RMDs for customers — but the final responsibility for making the correct RMD payment rests with individuals. Also, IRS form 5498, which is sent to all IRA account holders, indicates if an RMD is due for the coming year.
Here are some talking points for retirement plan sponsors to use when educating older workers about managing RMDs:
- Participants wtih multiple accounts need to calculate the RMD for each IRA separately. However, they can aggregate the amounts owed and make the withdrawals from whatever accounts they like. For other qualified plans — such as 401(k)s — those must be calculated and paid out separately from those accounts. Likewise, if participants have an inherited (or beneficiary) account, that RMD must be satisfied separately, too. One way to simplify the complexity of managing RMDs is to consolidate accounts at a single financial services provider, which can help manage compliance.
- If seniors still need to take a 2011 RMD this year, they are not exempt from making a 2012 withdrawal by Dec. 31. Warn them that this could push them into a higher tax bracket.
- Although most investors take the smallest RMD possible, there's no limit on how much they can withdraw without penalty after they reach age 59-1/2. "It might make sense for people with larger account balances to take out more now while income tax rates are low," says IRA expert Ed Slott. RMDs can be taken in a single lump sum, or through a series of timed distributions throughout the year. "That's a sort of reverse dollar-cost averaging," Hevert says.
- Encourage investors to consider converting all or some of tax-deferred holdings to a Roth IRA. A Roth conversion isn't right for everyone, and it's best to analyze this option with the assistance of a tax professional. However, a Roth conversion can alleviate the need for RMDs. Plan participants will owe income tax on all converted assets in the year of conversion, but assets grow tax-free from that point forward without RMD requirements. A Roth also can be an effective way to pass along tax-free assets to heirs. However, investors can't satisfy an existing RMD requirement by doing a Roth conversion. Take whatever RMD they already owe before executing a Roth conversion.
© 2011 Thomson Reuters. Click for Restrictions.
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