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When Do You Need to Start Taking Required Minimum Distributions (RMDs)?

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When you reach age 72, the government requires you to begin withdrawing money from your retirement savings accounts each year. This sum, known as a required minimum distribution (RMD), allows the IRS to begin collecting income tax on the dollars you’ve stashed away in tax-deferred accounts such as a 401(k) or traditional individual retirement account (IRA).

What is a required minimum distribution (RMD)?

Regulations governing most retirement accounts state that you cannot leave funds in the account indefinitely. Even if you don’t need the money, the government requires you to begin reducing the overall balance in most accounts by a set sum each year — the required minimum distribution — once you’ve turned 72.

The precise amount of each person’s required minimum distribution is determined by the IRS based on life expectancy and total savings. The RMD rule only applies to tax-deferred accounts or accounts that allow people to reduce their taxable gross income each year by the amount they set aside in the plan.

Because tax-deferred accounts provide upfront tax savings, the IRS waits to collect taxes on contributions to the accounts and any subsequent investment gains until the money is withdrawn. Here’s a full list of retirement accounts subject to the RMD rule:

  • 403(b)
  • 457(b)
  • Profit-sharing plans
  • Other defined contribution plans

RMDs are not required for Roth IRAs or Roth 401(k)s, since contributions to Roth accounts are made using money on which you’ve already paid income tax. Note, however, that beneficiaries who inherit Roth IRAs must take RMDs.

When do I have to start taking RMDs?

You need to start taking required minimum distributions by April 1 of the year after you turn 72. In subsequent years, you need to take RMDs by December 31st.

If you are still working at age 72 and have a traditional 401(k) or 403(b) account with your current employer, you may not have to take an RMD from that account unless you own 5% or more of the company. Review your plan’s exact terms to see if it allows you to wait until you actually retire to begin taking RMDs or if it follows the same 72 rule regardless of retirement status.

Employment, however, won’t help you delay taking RMDs from any individual retirement accounts outside of your employer retirement account, such as a traditional IRA.

You do not have to take your RMD as one lump-sum payment. The IRS allows you to take out the funds in chunks throughout the year too. As long as the total meets the RMD for the year, you’re in the clear.

You’re also not limited to taking only the RMD amount from your account each year — you can withdraw more than that threshold, if you want.

How do I calculate my required minimum distribution?

Just like filing your taxes, it falls on your shoulders to remember to take the RMD once you reach 72. You can do the math yourself (we’ll explain below) to figure out what your required minimum distribution will be, or you can ask for help from a tax professional or financial adviser.

To calculate your RMD, you need to know exactly how much you have saved in your retirement account as of Dec. 31 of the previous year. Next, use the table below (the IRS’s Uniform Lifetime Table) to find your “distribution period” score, which is based on your life expectancy.

To calculate the RMD, divide your retirement account balance by the distribution period that corresponds with your age. Repeat this step for each of your accounts to come up with the total amount you must withdrawal for the year. Remember, your account balances change over time and the IRS can update its distribution period figures, so redoing this math each year is crucial to ensure you take out the correct sum.

Let’s say you turned 72 in December 2020 and had a balance of $1 million in your retirement account as of Dec. 31. You would then find the distribution period that corresponds to your age in the Uniform Lifetime Table.

According to the table, your distribution period number is 27.4. When you divide $1 million by 27.4, you get an RMD of $36,496.35. That is the minimum withdrawal you must make from that account by April 1, 2021.

However, if you’re married and your spouse is 10 years or more younger than you and is the sole beneficiary of the retirement account, you will need to find your “distribution period” score on this alternate table by locating the spot where your age and your spouse’s age intersects.

For instance, if you turned 72 in 2020 and had that same $1 million balance in your retirement account on Dec. 31, but were married to a spouse who’d just celebrated their 59 birthday, your distribution period number wouldn’t be 27.4, but rather 28.1 to accommodate the longer expected lifeline of your spouse.

And this would mean you’d need to take an RMD of $35,587.19 from your account in 2021, or about $909.16 less than you would if you were single or married to a spouse closer to your own age.

What is the required minimum distribution penalty?

If you don’t take your first RMD by April 1 of the year after you turn 72 or your subsequent annual RMDs by Dec. 31 each year, you’ll be slapped with a 50% excise tax on the amount that was not distributed when you file taxes.

That’s a steep fine when you consider that the top tax rate is 37%, which is why it is so important to accurately calculate your RMDs each year, as the tax applies whether you fail to take any money from the account or simply don’t take enough.

For example, if your RMD was $10,000, but you only took out $5,000, you will be assessed that 50% tax on the $5,000 that you did not withdraw.

Remember, if you delay taking your first RMD until April of the year following your 72nd birthday, you’ll be required to take two withdrawals in the same year, one for your 71st year and one for your 72nd year, which could raise your gross income and move you into a higher tax bracket. To avoid this, you can opt to make your first withdrawal by Dec. 31 of the year you turn 71, instead of waiting till the following April.

Alternatively, you could reduce your taxable income by making a qualified charitable distribution paid directly from the IRA to a qualified public charity, not a private foundation or donor-advised fund. The charitable distribution can satisfy all or part of the amount you are required to take from you IRA and won’t count as part of your income.

If you withdrawal the RMD first, then donate it, this trick won’t work as the money will count toward your gross income.

What if I have multiple retirement accounts?

If you have more than one retirement account, things can get a little more complicated. You still need to take an RMD, but you don’t have to take one out of each IRA account. Instead, you can total the RMD amounts for all your IRAs and withdraw the whole amount from a single IRA or a portion from two or more.

However, you can’t do the same with most defined contribution plans, like 401(k)s. With these accounts, you must take an RMD from each plan separately. One exception to this rule, though, is 403(b) tax-sheltered annuity accounts. If you have multiple of these accounts, you can total the RMDs and withdrawal from a single account.

If you own several different kinds of retirement accounts with RMDs, it’s probably a good idea to seek advice from a tax or financial adviser professional who can help you make the wisest decision for your finances.

I inherited a traditional IRA — what should I do?

While it’s great to be left the generous gift of a retirement account by a loved one, inheriting an IRA comes with its own set of tricky RMD rules that can vary greatly depending on your relationship with the original owner and how you chose to use the account.

I inherited a traditional IRA from my spouse

If you’re a spouse and sole beneficiary, you have the most flexibility in how to handle your new IRA. You can choose to treat the IRA as your own by designating yourself the account owner and making contributions or by rolling it over into an existing IRA account that you own. If you choose this option, you can follow the standard RMD rules — meaning you can wait until you turn 70½ to begin taking money from the account.

Alternatively, you can roll the assets into what’s known as an inherited IRA. With this kind of account you can start taking distributions immediately and not face the typical 10% early-withdrawal penalty the IRS applies if you’re under age 59½.

To calculate the RMD you’ll need to take with this kind of IRA, use the IRS’s Single Life Expectancy Table, which has different distribution period figures than the standard table you would use if you were the original account owner. You can opt to use your own age for these calculations or your partner’s age as of their birthday in the year they died, reducing life expectancy by 1 each subsequent year.

But you may not need to take RMDs right away depending on how old your spouse was when they died. If they were older than 70½ then you’ll need to start withdrawing funds by Dec. 31 of the year following their death. But if they were younger, the IRS lets you leave the money in the account until your spouse would have reached 70½.

I inherited a traditional IRA — but I’m not a spouse

Beneficiaries who are not a spouse are required to move the assets into an inherited IRA and begin taking RMDs regardless of the original owner’s age. If the person passed before age 70½ you can opt to withdraw the full balance within the five years following the year of their death. Or you can prolong the payouts by taking RMDs annually based on your age, reducing beginning life expectancy by 1 for each subsequent year, using the Single Life Expectancy Table.

If the original owner was 70½ or older, how you calculate your RMDs depends on whether you or the deceased was younger. The lowest age is what you’ll base your life expectancy figure found in the Single Life Expectancy Table on, though you will need to reduce beginning life expectancy by 1 every subsequent year.

I inherited a Roth IRA — what should I do?

The original owner of a Roth IRA never has to take RMDs but that can change when the account passes to a beneficiary. A surviving spouse who inherits a Roth IRA can opt to treat the account as their own, meaning they won’t ever need to take an RMD, if they contribute to the account or roll into an existing Roth IRA.

Non-spouse beneficiaries, however, do have to take RMDs from an inherited Roth IRA, following the same rules as those who inherit traditional IRAs where the owner passed before reaching age 70½.

That means these beneficiaries can either withdraw the entire balance from the Roth IRA within the five years following the year of the original owner’s death or begin taking RMDs based on your life expectancy, as outlined in the Single Life Expectancy Table, by the end of the year following the owner’s death.

The final word on required minimum distributions

Whether the retirement account was yours to begin with or you’ve inherited it, calculating the correct RMD amount to withdraw from it every year can be tricky, but spending the extra time to make sure you understand the rules and check your math can pay off big time when you’re not losing 50% of your savings to Uncle Sam in the form of a tax penalty.

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Life Events, Mortgage

What is Mortgage Amortization?

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The difference between your home’s value and how much you owe on your mortgage is your home equity. With each mortgage payment you make, mortgage amortization — or paying down the loan in installments — is at play, and each monthly payment brings you closer to owning your home outright.

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What is mortgage amortization?

Mortgage amortization is the process of paying off your loan balance in equal installments of principal and interest for a set time period. The interest you pay is tied to the balance of your loan (your principal) and the mortgage rate. When you first start making payments, most of the payment is applied to the interest rather than the principal.

Your principal payments catch up with interest over time until your loan is paid off. Once it reaches a zero balance, it becomes a “fully amortized loan.”

How mortgage amortization works

The easiest way to understand mortgage amortization is to look at how monthly mortgage payments are applied to the principal and interest on an amortization table. There are two calculations that occur every month.

  1. The first calculation measures how much interest is paid based on the rate you agreed to. The interest charge is recalculated each month as you pay down the balance, and you pay less interest over time.
  2. The second calculation reflects how much of the principal you pay. As the loan balance shrinks, more of your monthly payment is applied to your principal.

If you’re a math whiz, here’s the formula:

A mortgage amortization calculator does the heavy lifting for you. You can see the effects of amortization on a 30-year fixed loan amount of $200,000 at a rate of 4.375% below.

In the first year, you pay more than twice as much toward interest as you do toward the principal. However, the balance slowly drops with each additional payment. By the 15th year, principal payments outpace interest and equity starts building at a much faster pace.

How mortgage amortization can help with financial planning

A mortgage amortization table helps you assess the short- and long-term benefits of adjusting your mortgage payments. Making extra payments over the life of the loan or refinancing to a lower interest rate or term could save you thousands in interest charges over the life loan. Even better: you’ll end up with a mortgage free home sooner.

Using a mortgage calculator to configure a few scenarios, here are some financial goals you might be able to accomplish using mortgage amortization.

Calculate how much money you can save by refinancing

If mortgage rates have dropped since you bought your home, consider refinancing. If you’re in your forever home and don’t plan to move for a while, a half-percentage point drop in rates could make room in your budget to boost retirement savings, your emergency fund or put money toward other long-term financial goals.

The example below shows the monthly payment and lifetime interest savings if you replaced a 30-year, fixed-rate loan for $200,000 at 4% with a new loan with a 3.5% interest rate with the same terms.

While saving $56.74 per month on payments doesn’t seem like much, it adds up to $20,426.83 in interest savings over the loan’s lifetime.

See the effect of making extra payments

The amount of interest you pay every month is directly connected to your loan balance. Even a small amount added to the principal each month reduces interest over time. The graphic below shows how much you’d save adding an extra $50 every month to your payment on a $200,000, 30-year fixed loan with an interest rate of 4.375%.

Figure out when you can get rid of PMI

Borrowers who don’t make a 20% down payment on a conventional mortgage typically pay for private mortgage insurance (PMI). The coverage protects a lender against financial losses if you don’t repay the loan.

Once your loan-to-value ratio, or the loan balance in relation to the home’s value, reaches 78%, PMI automatically drops off. Multiply the price you paid for your home by 0.78 to determine where your loan balance would need to be for PMI to be canceled. Locate that balance on your loan payment schedule for a rough idea of the month and year PMI will end.

Decide if it’s time to refinance an adjustable-rate mortgage

Adjustable-rate mortgages (ARMs) are a helpful tool to save money on monthly mortgage payments. However, ARMs make more sense if you plan to refinance the loan or sell your home before the initial fixed-rate period ends and the loan resets to a variable interest rate.

An adjustable-rate mortgage amortization schedule helps you pinpoint when the loan will reset and gives you an idea of the worst-case scenario on payments. If the adjustments are outside of your comfort zone, consider refinancing your ARM into a fixed-rate mortgage.

The difference between a 15-year fixed and 30-year fixed payment schedule

Refinancing to a shorter term, such as a 15-year fixed mortgage, may save you hundreds of thousands of dollars over the life of a loan — but the trade-off is a higher monthly payment.

The graphs below show the difference between a 30-year amortization schedule for a $200,000, fixed-rate loan at 4.375% and a 15-year amortization schedule for the same loan amount at 3.875%.

The lifetime interest savings for a shorter loan payment schedule is $95,447.16. As long as the $468.31 increase in your mortgage payment doesn’t prevent you from meeting other savings or investment goals, the long-term savings are worth it.

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College Students and Recent Grads, Eliminating Fees, Life Events

When to Avoid a Company 401k

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Gone are the days of workers depending upon pensions when they retire. Today, instead of offering defined benefit pensions guaranteeing an employee a monthly payment for the rest of his or her life, employers are moving to more employee-managed retirement savings plans.

Today, more employers offer a 401k plan – if they have an employer-based plan at all. With a 401k, employees make a defined contribution from their income each year. With a pension plan, employees knew exactly how much income they could depend on each month during retirement. Now, it is up to the employees to determine how much they need to save in order to reach their retirement savings goals.

A 401k allows employees to make defined contributions, pre-tax (or post-tax), towards retirement. If you contribute to a traditional 401k, contributions are automatically deducted from your paychecks each pay period, pre-tax. As a result, you don’t pay taxes until money is withdrawn from the account and you cannot withdraw money before 59 ½ without penalties. Some employees offer the option to contribute post-tax in a Roth 401k, so money withdrawn in retirement will not be taxed.

With this change toward employee-directed retirement, rather than retirement guaranteed by the employer, it is up to you to make the best decisions regarding your retirement savings. This could mean it’s best to avoid a company 401k.

Take a look at these situations in which you should not pay into your employer’s 401K, and see if any of them apply to you.

No Employer Match

Many employers provide a match to their employees’ 401k contributions. Employer matches vary greatly by employer, but a common example of this is $0.50 per $1.00, up to 6% of employees’ pay.

Let’s say you earn 40,000 per year at your current job, and your employer provides a $0.50 per $1.00 match, up to 6% of your pay. If you were to contribute the full 6% of your pay annually, you would contribute a total of $2,400 to your 401K over the course of a year. Your employer would then contribute $0.50 for every dollar you contributed, for a total of $1,200 for the year.

In total, over the course of the year your 401K would contain $3,600, and you only would have contributed $2,400 of the balance.

But if your employer does not provide a match, it may be time to reconsider contributing to its 401K plan. Never walk away from an employer match, but if your employer does not provide a contribution match, it may be time to consider other options like saving for retirement in a traditional or Roth IRA.

You Have Reached The Contribution Limit

Effective January 1, 2020, the 401k contribution limits are $19,500 if you are age 49 and under. If you are 50 or older, you can contribute an additional $6,500 above and beyond the $19,500 regular contribution, for a total of $26,000. Of course, you are free to contribute less to a 401K, but saving as much as possible for retirement is always best.

Once you have reached the contribution limit on your 401k, you cannot make any more contributions pre-tax, and it is time to consider alternative investments.

One good alternative is a Traditional IRA. Contributions are made to a traditional IRA after tax, meaning that you pay taxes, and then make contributions out of your paycheck. For 2020, individuals can contribute up to $6,000 per year to a traditional IRA if they are 49 and under. You can contribute up to $7,000 per year if you are 50 or older.

Another solution for aggressive savers is a taxable account such as stock index funds. When using taxable accounts such as these, you can expect to pay 15% on long-term gains and qualified dividends. Additionally, contributions to these plans are made after-tax. However, the benefits of using accounts such as these include being able to withdraw from them for things such as children’s college expenses before age 59 ½ without additional penalties and fees.

You Qualify For a Roth IRA

If you employer does not offer a 401k match – or a 401k plan at all – and you meet income thresholds, then a Roth IRA may be an excellent option for your retirement savings.

A Roth IRA allows individuals whose modified adjusted gross income, which you can calculate at the IRS website, is less than $139,000, or married couples whose income does not exceed $206,000 to contribute to their retirement.

A Roth IRA is different from other accounts, though, because of the way taxes are handled. Contributions are made after tax. However, once the initial contribution is made, you enjoy tax-free growth as long as you follow the rules:

  • 49 and under can contribute a maximum of $6,000
  • 50 and over can contribute up to $7,000
  • You can withdraw your contributions (not growth) at any time without penalty

How much can a Roth IRA save in taxes? If you contribute $5,500 per year to a Roth IRA for 40 years, and your marginal rate is 15%, this is what your account’s growth could look like over the course of 40 years:

401k_1

In this scenario, you would have only paid in $230,000 during the entire 40 years you worked. You would have paid $34,500 in taxes from your paychecks.

However, your relatively small investment could grow to $1,189,636 – and you will not have to pay taxes on any of that balance when you withdraw it. If your marginal tax rate stayed at 15% when withdrawing money from your Roth IRA, you could save more than $143,000 in taxes alone.

See how much money you can save with a Roth IRA, and how much money it can save you in taxes here, with Bankrate’s Roth IRA calculator.

High Fees

If your employer offers a 401k without a match, a good way to gauge whether it is a good investment vehicle for your retirement savings is to take a look at the fees. Many times both employees and employers are unaware of just how much fees are costing them. After all, 3% seems like such a small number, doesn’t it?

3% may feel like a very small amount to pay in fees, but this example will show you just how much a small percentage can affect your retirement savings.

401k_2

In this example, the investor is a 29 year old, contributing $18,000 per year to her company’s 401k, and her retirement age will be 65. The current balance of their 401K is $100,000, and fees are 3%.

Just by switching to a plan that cuts fees in half, 1.5%, she could save $801,819.03. Instead of having $1.8 million upon retirement, she could have more than $2.6 million – making for a much better retirement.

You can check out a fee calculator here and find out just how much your fees are costing you!

Even if your 401k has high fees, be sure to consider the employer match. Many times the match will more than cover the fees, making the 401k a good investment vehicle in spite of the high fees.

If You Need Flexibility

401k’s, while they offer tax advantages do not offer any sort of flexibility. Contributions are automatically deducted pre-tax from an employee’s paycheck in pre-set amounts, and cannot be withdrawn without serious penalties until age 59 ½.

For many families, saving and investing money is not just about retirement. It is about college, medical expenses, large purchase, and even vacations. Always contribute to your 401k up to the maximum amount that your employer will match, but if no match is available and you need flexibility for other savings priorities, check out some of these options:

A 529 Plan: An education savings plan operated through your state or an educational institution to help families set aside income for education costs. Although contributions are not deductible on your federal income tax return, the investment grows tax-deferred, and distributions used to pay the beneficiary’s college costs come out tax-free. Some states offer tax breaks for 529 contributions, you can find yours here. In addition, there are very few income and contribution limitations, making the 529 plan a great, flexible way to save for college.

A Health Savings Account: An HSA offers individuals and families the opportunity to save money exclusively for medical expenses, and contributions are 100% tax deductible from gross income. For 2020, individuals can contribute up to $3,550, and families are allowed to contribute up to $7,100. HSA accounts holders age 55 and older can contribute an extra $1,000. If using savings for medical expenses if a priority, talk to your employer about an HSA. Not all insurance plans are eligible.

Taxable Investment Accounts: When saving for large purchases or vacations, more flexible accounts are better. As explained above, index funds, mutual funds, or even traditional savings accounts leave the account holder with more of a tax burden, but far greater flexibility for withdrawals. These accounts do not need to be opened through your employer, but can be opened and managed on your own, or with the help of a financial planner.

If your employer offers a contribution match go ahead and take advantage of the 401k, regardless of high fees or a low income. However, if your employer offers no match, high fees, or you have reached the yearly contribution limit, then it is a good idea to avoid that 401k plan and look into other retirement savings options.

At the end of the day, saving for retirement or other goals is all about you. How much flexibility you need, how much you need to save, and your tax situation. Be sure to weigh all of your options to guarantee that you are making the best decision for you and your family.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.