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7 Mistakes to Avoid When Taking Distributions

Ignoring these traps could cost you money

  • Required Distributions

    The Final Piece of Your Retirement Puzzle

    It's great that you've been saving for retirement in vehicles such as traditional IRAs and 401(k)s. The next step will be taking the money out, and doing it the right way can save you a bundle. In general, you must begin withdrawing money by April 1 of the year following the year that you turn 70 1/2. Here are seven traps to avoid when the time comes to take the required minimum distributions (RMDs). Keep in mind that these are general mistakes, meaning your individual circumstances may differ, and that there is nothing simple about taxes. They were developed with the help of Mike Piper, author of Can I Retire?

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  • Required Distributions  - The penalty for not meeting this required distribution is a very stiff 50% of the amount that should have been withdrawn.

    Forgetting to take the RMD

    The penalty for not meeting this required distribution is a very stiff 50 percent tax on the amount not withdrawn. I'd call this the mother of all RMD mistakes. The IRS does, however, allow you to file a waiver request if you can establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall.

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  • Required Distributions  - Though it’s true that you have until April 1 of the following year that you turn 70 1/2

    Waiting until the following year to take your first-year RMD

    Though it's true that you have until April 1 of the year following when you turn 701/2, delaying your withdrawal means you will have to take two RMDs that year, since the second must be taken by Dec. 31. This could throw you into a higher tax bracket and leave you with less to live on.

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  • Required Distributions  - wait until age 70 to start receiving Social Security

    Not taking any distribution before it's required

    I typically tell clients to wait until age 70 to start receiving Social Security, so that they'll receive the maximum benefit. The result is that their income may then go up substantially, but they also may be taxed on both the Social Security payments and the RMDs. So taking money out of your traditional retirement accounts before it's required can be a good thing, as it lowers the amounts you'll have to take out later. The goal is to pay taxes a bit sooner at a lower rate than later at a higher rate. You can either withdraw funds or, if you're not going to spend the money, convert to a Roth IRA, which has no RMD.

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  • Required Distributions  - Taking all of the RMD from one account if you have both a 401K and an IRA.

    Taking all of the RMD from one account if you have both a 401(k) and an IRA

    It's true that you can aggregate all of your IRA accounts and take the RMD from any one account. But that doesn't apply to 401(k) retirement accounts. You must take your RMD individually from each 401(k) account. If, for example, you have two 401(k) accounts and two IRA accounts, you must take a minimum of three distributions — one each per 401(k) and at least one combined for the two IRAs.

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  • Investing Lessons Learned from Warren Buffett - Stick with what you know.
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    Not using your RMD to contribute to charitable organizations

    If you are going to contribute to a nonprofit organization, it often can be beneficial to make a qualified charitable distribution from your IRA. Unlike an itemized deduction for a charitable contribution, using a qualified charitable distribution for your RMD has the effect of reducing your adjusted gross income. This can sometimes make you eligible for other tax breaks as well, or it could lower your income enough to reduce Medicare premiums.

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  • Required Distributions  - Not using your RMD to contribute to charitable organizations

    Thinking your RMD is income

    Though the IRS considers it income, and you have to pay taxes on it, that doesn't make your RMD true income in the economic sense. It doesn't increase your financial net worth. Thus, you can't add this amount to what you consider the safe spend rate for your total nest egg.

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  • Required Distributions  - Thinking your RMD is income

    Thinking you have to spend your RMD

    Following from the point that the RMD isn't true income, you don't have to spend the money if you don't need it to live on. You merely are taking it out of a tax-deferred account and moving it to a taxable account. In fact, you can even keep the same asset allocation by letting it remain in the same investments, such as stock or bond index funds. Withdrawing your money from retirement accounts the right way can leave you with more money after taxes. That's a very good thing. But taxes are complex, and you should consider talking to a tax adviser before implementing strategies to avoid these seven traps.

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  • Money Channel Slide Show end slide

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    Now that you know what tax distribution mistakes to avoid, read up on how to pay less taxes in retirement.

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