required minimum distributions (RMDs)

A Simple RMD Mistake That Can Cost Retirees Thousands

Do you know exactly what your required minimum distribution should be? Did you take more than you had to last year? If you need extra cash, there could be a better place to get it.

It is fairly common for people taking required minimum distributions out of retirement accounts, such as IRAs, to pull out more than the required amount, often without even being aware they are doing so — triggering unnecessary taxes. Because retirees are often using retirement accounts for income, it’s very common for them to contact a well-meaning employee at their financial institution and tell them to set them up to get monthly income from their IRA that may be more than their RMD amount.

For some people who have a carefully crafted broad tax strategy, it may make sense to pull out more than the minimum RMD (please see Should You Take an Extra Big RMD This Year?). But others aren’t being as thoughtful about their decision. If you need the extra money and there’s no other investment or bank account to take withdrawals from, this would be fine. However, in most cases where this occurs there are other non-retirement investment accounts or bank accounts where such withdrawals can be taken, while triggering far less in taxes, or sometimes no taxes at all.

How Can You Find Your RMD Amount?

To avoid getting hit with unnecessary taxes, you need to have a firm understanding of what your required minimum distribution should be. The easy way to verify whether you’re taking more than your required minimum distribution is to simply call the institution where you have your IRA and ask them, “How much in withdrawals did I take from my IRA in 2020? How much was I actually required to take? And what should my RMD be for 2021?” 

You can also verify your RMD by doing the calculation yourself. You could try a simple online calculator, such as Kiplinger’s RMD calculator. Or you could do it manually, too. To get started, go to the uniform lifetime table (or the joint life expectancy table if your spouse is more than 10 years younger) at the IRS website and locate what is called your “distribution period” number, based on your age in the year of the RMD you’re calculating. You would then divide the market value of your IRA on December 31 of the previous year by this number, and this will show your required minimum distribution.

For example, say Joe is concerned he may have taken a bigger RMD from his IRA last year than he needed to. In 2020 he was 75 and his wife was 72. He would check the balance of his IRA at the end of 2019 — say it’s $458,000 — and then divide that number by 22.9 (from the IRS uniform lifetime table). His RMD would be $20,000.

Next, Joe would grab his 2020 tax return and look at line 4b, which would show his taxable IRA withdrawals, so he could verify whether you took more than the RMD amount.

It’s a little different if you’re taking required minimum distributions out of a company plan, such as a 401(k). You would look on line 5b to see the taxable withdrawals. But verifying RMDs on a company plan requires an extra step, because line 5b combines withdrawals from the company plan, such as a 401(k), with income from pension annuities. You would need to first check your 1099s and separate out withdrawals from the company plan, from amounts coming out from pension annuity payments. Once you verify the withdrawal amount from the company plan you can go to the uniform lifetime table (or the joint life expectancy table if your spouse is more than 10 years younger) and do the same calculation to see if you took more than the required minimum distribution.

How Much Could Your Mistake Costing You?

Let’s go back to Joe. His RMD for 2020 should have been $20,000. He looks on line 4b of his 2020 tax return, and it shows he took taxable distributions of $28,000 that year. This means he pulled out $8,000 more than was required. If Joe was in a 24% tax bracket, this cost him $1,920 in taxes that was very likely unnecessary.

To remedy this yourself, you would want to calculate your required minimum distribution for the current year and make sure, if at all possible, you take no more than this required amount.

Where to Pull the Money from Instead of Your Retirement Account

If you need additional funds beyond your RMD amount, you could avoid paying unnecessary taxes if you take a moment and think about all the different accounts you have available to you besides your IRA. You could take the extra funds from a non-retirement account, if you have this option available. For example, pulling money out of a bank checking or savings account to cover extra expenses will normally trigger zero taxes.

And even if you liquidated part of a typical stock and bond portfolio in a non-retirement account to take needed funds above your RMD amount, because you’d be dealing with more advantageous capital gains taxes, the tax impact would be far less than taking fully taxable retirement plan withdrawals.

There’s an old saying that says “the little foxes spoil the vine.” Taking the time to check little things like the amount you’re taking in taxable IRA withdrawals may save you a few thousand in taxes.

About the Author

Mike Piershale, ChFC

President, Piershale Financial Group

Mike Piershale, ChFC, is president of Piershale Financial Group in Barrington, Illinois. He works directly with clients on retirement and estate planning, portfolio management and insurance needs.

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