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Forced to Withdraw Money
Qualified retirement accounts are those that qualify for special tax treatment from the IRS. The most common of these accounts are 401(k) plans, IRAs, both traditional IRA and Roth IRA, and an assortment of self-employed retirement plans or small business retirement plans like SEP-IRA, SARSEP, and others.
With the exception of Roth IRAs which have their own tax rules, each of these accounts has a self-destruct type mechanism built into them. Since 401k plans, and IRAs offer huge tax advantages by deferring all taxes on growth and income until the funds are withdrawn, there was a concern that people would intentionally leave money inside of these accounts. Doing so would deny the government it’s ability to tax these monies, particularly if they were left to a spouse.
To avoid this situation, the IRS mandates that all persons begin withdrawing funds from their qualified accounts like traditional IRAs and 401ks in the year after they turn 70 ½ years old. This mandatory withdrawal is called Required Minimum Distribution or RMD.
RMDs are calculated based upon life expectancy tables published by the IRS and the amount of money inside of the accounts. Essentially, the RMDs start small and get progressively larger as the account holder gets older, reflecting the increasing chance of the owner dying before withdrawing the money inside of the 401k or IRA.
These RMDs are an important consideration when choosing retirement investing options, as well as when managing your portfolio in retirement.
To minimize the impact of RMD withdrawals on your portfolio there are some moves that you can make.
If you already have substantial investments inside of qualified accounts, consider opening a Roth IRA or investing in tax efficient investments outside of your traditional IRAs and 401k plans. In addition, once you turn 59 ½ ensure that you are actively using funds from inside of your qualified accounts for living expenses. This will make for a lower account balance against which RMD calculations will be made.
Additionally, it will leave assets for which there are no RMD requirements to be the ones that grow the largest as you approach age 70 ½ and beyond.
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Special 2009 RMD Waiver Rules
The large investment losses experienced in many IRA accounts and 401k plans led Congress to provide a special RMD exemption for 2008 and 2009. Investors with IRA accounts may skip RMDs that would have normally been required. Thus, an IRA investor does not have to withdraw ANY money during 2009 regardless of how old they are. This special 2009 RMD waiver is temporary for one year only. Regular RMD withdrawals will be resumed in 2010.