It's Almost Year-End: Do You Know Where Your RMDs Are?

Between shopping, decorating, and making time for a little holiday cheer, the concept of squeezing in financial-planning tasks between now and year-end may seem almost laughable. True, year-end is the perfect time to take steps to reduce your impending tax bill through tactics like tax-loss selling. But it's not an absolute disaster if portfolio-related tasks like rebalancing wait until another time of the year, when you can tackle them with a clear head.

But forgetting to take your required minimum distributions from your retirement accounts before year-end? A disaster, plain and simple.

Although retirement-account distributions were optional for 2009, in an effort to give retiree accounts time to regroup following the harrowing market sell-off of 2008, they're required again for 2010. Under the RMD rules, retirement-plan and IRA owners must begin taking minimum distributions by April 1 of the year following the year in which they turn age 70-1/2. They must then continue to take distributions by Dec. 31 of each year thereafter. These distributions are required to keep people from skirting taxes on their retirement accounts for years and years into the future.

Here's the potentially disastrous part: For any distribution that seniors should have taken but didn't, they'll owe the Internal Revenue Service an excise tax amounting to 50% of that amount--one of the most punitive levies in the whole tax code. The IRS' site says that tax will be waived if "the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall." But you should avoid messing around with the IRS if you can.

Here are some tips to bear in mind as you gear up for RMD season, including some ways to be strategic about which specific investments from which you draw your RMDs.

Who's on the Hook for Them
Roth IRA owners don't have to take RMDs during retirement, and that flexibility is a valuable benefit for people who don't need the distributions for living expenses. But participants in 401(k), 403(b), and 457 plans must take RMDs at age 70-1/2, as do holders of traditional, SEP, and SIMPLE IRAs. (I wouldn't guess that there are many seniors with substantial sums in Roth 401(k)s, but those accounts are subject to RMDs, too.)

The one exception to the RMD rule is if a person is still working at age 70-1/2 and has a retirement account at that same employer. In that case, the person doesn't have to take RMDs from that account until April 1 of the year following the year in which they actually retire.

It's (Number) Crunch Time
Calculating your RMD amount is pretty straightforward: You look back to your IRA account balance at the end of the previous year (Dec. 31, 2009, in the case of RMDs for 2010), then divide it by a factor based on your life expectancy. The IRS' website includes some worksheets for calculating your RMDs, but online calculators also abound, such as this one from T. Rowe Price.

Note that any good online calculator should ask you to input whether your spouse is your beneficiary and if so, what his or her age is. If your spouse is 10 or more years younger than you and also the beneficiary of your account, your RMDs will be lower than if your spouse is within 10 years of your own age. The thinking behind this rule is that much older spouses shouldn't have to deplete their nest eggs when the younger spouse could be around for many more years.

Also, be aware that the RMD simply refers to the total amount you're required to take out of your account in a given year. For seniors who are drawing heavily on their retirement accounts for living expenses, the concept of RMDs may be irrelevant because they're already withdrawing more than enough to meet the requirement.

Strategy Session
Determining how much of an RMD you need to take is straightforward. What can get more complicated, however, is from where you get your RMDs. Many of you hold multiple retirement vehicles and within them, multiple investments. And the RMD rules actually give you a good bit of discretion over the accounts from which you take distributions.

For example, say you have multiple traditional IRAs--one with Fidelity, one with Dodge & Cox, and one with Schwab. You could go account by account and take the appropriate RMD from each. However, it's also possible to total all of those IRA balances as of year-end 2009, find your total RMD for 2010, and withdraw that amount from just one of those accounts.

The hitch is that you can't combine RMDs from disparate retirement vehicles. So say, for example, you hold three traditional IRA accounts as well as a 401(k) from a former employer. You could combine the three IRAs for RMD purposes, as in the example above, but you couldn't add in the 401(k). Instead, you'd have to calculate and take your 401(k) distribution separately.

That flexibility allows you to be strategic about where you take the money from and enables you to link RMD time with rebalancing. Say, for example, you've compared your portfolio's current weightings with your target allocations and found that your portfolio is heavier on bonds than it should be. Assuming your bond holdings are concentrated in a single IRA account, you could meet your RMDs by tapping that account while leaving your other holdings intact. Taking your RMDs may not be enough to get your account back into whack, but it could be a good starting point.

Fitting RMDs into the rebalancing process also helps ensure that you're not paying any more taxes than needed. Yes, you'll owe at least some taxes on your RMDs, provided they come from a traditional IRA or 401(k). But you'll have to pay those taxes regardless, whereas rebalancing within your taxable accounts could entail capital-gains taxes that you didn't absolutely have to pay.

Put It on Autopilot
If you don't have the time or inclination to be strategic about RMDs, that's fine, too. Just be sure to take them. One simple way to ensure you don't miss the deadline is to sign up for automatic RMDs through your financial providers. That way you'll definitely take your distributions on schedule. This is a great option for older seniors who aren't in the mood to manage a lot of details or for adult children who are helping elderly parents simplify their investment lives.

If you go this route, however, make sure you have adequate liquid assets (for example, cash or short-term bonds) in the account from which to draw. The last thing you want is for your investment providers to have to sell less-liquid holdings like stocks at what could be an inopportune time just to meet RMDs.

Reinvesting RMDs
Some seniors I know find that their RMDs come at an ideal time to pay for so-called extras, such as holiday gifts, winter vacations, and so forth. But if you don't need or want to spend your RMDs, you absolutely can continue to save and invest them, just not within the confines of a traditional IRA. (You can't make additional traditional IRA contributions once you're past age 70-1/2.) You can take your RMDs and plow them into a Roth IRA, but there's an important caveat. You must have enough earned income to cover your contribution. If you've earned enough from a job to cover the amount of your Roth IRA contribution, you're in the clear. But if your only income comes from investments, you can't make a Roth contribution.

See More Articles by Christine Benz

		New! 30-Minute Money Solutions
	Need help picking up the pieces in this turbulent market? 30-Minute Money Solutions by Morningstar director of personal finance Christine Benz simplifies the daunting task of getting your financial house in order. Written for novice and experienced investors alike, this book offers manageable, step-by-step solutions for tackling money challenges and building a comprehensive financial plan in simple 30-minute increments. Learn more.
	Order Your Copy Today--$16.95