Rookie Retirement Error: Taking Late RMDs

If you’re an investor of a certain age, here’s a gentle reminder: don’t leave your RMD to the last minute.

RMD is short for required minimum distribution, an annual withdrawal from a traditional IRA, 401(k) or similar retirement plan. RMDs must begin after the investor turns 70½. They have to be done by the end of the year, except in the year you turn 70½, when the deadline is the April 1 the following year.

Some investors could overlook this requirement because it was waived last year to make life a little easier in the recession. But that was just a one-year deal. Forgetting an RMD is a big mistake, triggering a penalty of 50% of the amount that should have been taken.

Although your retirement accounts could rise or fall by the year-end deadline, that won’t affect the required distribution because it is based on values on Dec. 31, 2009. But it can pay to take the RMD before year-end if you plan to reinvest the money and see a promising opportunity. So here’s a reminder of a few RMD basics.

First, why do so many investors consider this a burdensome requirement? It’s because standard investing strategy calls for leaving money in tax-favored plans like IRAs and 401(k)s for as long as possible, allowing tax deferral to boost compounding. Like all withdrawals from these accounts, RMDs are subject to income tax.

A $10,000 withdrawal could trigger a $2,500 tax for someone in the 25% tax bracket. (There’s no RMD for Roth IRAs and Roth 401(k)s, because their withdrawals are tax-free.)

Basically, the required amount is figured by dividing the account’s value on the previous Dec. 31 by the investor’s life expectancy according to government tables. If you were expected to live 20 more years, you’d have to withdraw one twentieth, or 5%. For a $100,000 account, you’d have to take out $5,000, and pay a $1,250 tax at the 25% rate.