(Maurie Backmann)
There’s a reason workers are often encouraged to save money for retirement in a tax-advantaged savings plan, like an IRA or 401(k). If you’re going to make the effort to build up a nest egg, you might as well take advantage of some great tax cuts along the way.
But while saving in a IRA or 401(k) plan makes a lot of sense, these accounts have some drawbacks. For one, you’ll face penalties if you withdraw funds from any of these plans before age 59.5 (although some limited exceptions apply). And while it could be argued that this is a good thing, since it encourages savers to leave their money alone until retirement, it also leaves workers who choose to end their careers in their 50s in a hard situation.
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Another downside to keeping your retirement savings in an IRA or 401(k) is that your money can’t just stay in your account enjoying tax-efficient growth forever. On the contrary, the IRS requires you to start withdrawing from your savings at age 72. And if you don’t follow this rule, you could face huge penalties.
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Don’t ignore your RMD
If you have a Traditional IRA, Traditional 401(k), or Roth 401(k), you are required to begin making annual withdrawals once you reach age 72. These are known as minimum required distributions (RMD), and they are calculated based on your account balance and your life expectancy.
Now your first RMD is due April 1 after the year you turn 72. So if you turned 72 last October, you have several months to withdraw that money from your IRA or 401(k).
But all subsequent RMDs must be passed by December 31 each year. So if you’re in your mid-70s, for example, and haven’t yet taken your RMD for 2022, you have less than a month to withdraw that money.
What happens if you don’t take your RMD? You incur a penalty equal to 50% of the amount you were supposed to withdraw but did not. So if you’re on the hook for an RMD of $10,000, not taking that withdrawal will cost you $5,000 initially.
Avoid RMDs
For some seniors, RMDs are not a problem. This is because they have to withdraw from their savings to supplement their Social Security advantages. But other seniors find RMDs a burden.
Now, the good news is that RMDs withdrawn from a Roth 401(k) do not create tax because Roth 401(k) withdrawals are generally not subject to tax. But in this scenario, you still lose the ability to keep your invested money in your Roth 401(k), where it can grow tax-free.
If you don’t like the idea of having to withdraw money from your savings during your retirement, you might want to keep your money in a Roth IRA. In addition to tax-free withdrawals, Roth IRAs offer the advantage of not taxing RMDs. As such, they are a good place for your money if you want to bequeath some wealth to your heirs.
Don’t miss this deadline
Throwing away money is something you would probably prefer not to do. But if you don’t take your 2022 RMD by December 31, that’s what will happen. Rather than waiting until the last minute, go ahead and withdraw that money from your account as soon as possible so you can check that task off your list.
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