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Required Minimum Distributions, When to Take Them?

By Scott Chan on January 15, 2018

Tax-deferred retirement accounts, such as IRAs, provide a good way for Americans to build and grow their savings. But the IRS requires account holders, by the age of 70½ years, to take money out of these accounts. The least amount of money he or she must withdraw each year is called a Required Minimum Distribution (RMD). These distributions are taxable.

You must take your first RMD by April 1 in the year following the year you turn 70½ years old. If you wait until the second year to take your first RMD, however, you will need to take another one by December 31 because you also need to take an RMD for that second year. After that, as long as you take your RMD within the calendar year, the IRS does not care when exactly you withdraw your money. This leaves investors with a choice: when is the best time to take the money out?

Early or Late Distribution?

We are now about two weeks into 2018, and some people have already taken their RMDs. People usually do this only when they need money right away, or they think the market will fall during the year. Sometimes, people will also take RMDs early if they want to avoid the risk of passing away before they can take that year’s RMD, which would create a complex situation for heirs. Thus, it may make sense for someone in poor health to take the RMD early.

However, most people choose to wait until the end of the year to withdraw the RMD. The longer the money stays in the investment account, the more time it has to grow. Historically, the stock and bond markets have had more good years than bad, so in general, waiting until late in the year has been a good strategy.

If the market falls during the year, though, waiting until the end to take the money out would be counterproductive. However, in most years that is not the case.

The biggest con to waiting is the risk of missing the December 31 deadline. The RMD process could take as little as two or three business days to process. However, there’s always a chance the RMD cannot be processed in time if you wait until the last minute. If you miss the deadline, you need to pay a 50% tax penalty in addition to the regular income tax you have to pay.

Installments and Roth Conversion

Setting up automatic distributions is another option. You can choose to receive distributions in monthly or quarterly installments. This sets up regular streams of cash flow and eliminates the chance that you may forget to take your RMDs in time.

You must calculate how much RMD you have to take each year. The IRS leaves that responsibility to you. Fortunately, there are calculators available online that can help you. And many financial providers can offer that service as well.

You can also convert the account to a Roth IRA, which has no minimum distribution rules. You will need to pay a one-time income tax on the amount you convert, but after that you will have the freedom to withdraw money from the account whenever you please.

Of course, every individual’s situation differs so there’s no one-size-fits-all approach. When in doubt, it’s best to contact your accountant or financial services consultant.


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