Don’t Fear the Reaper

It may be a bit of a stretch to work in a Blue Oyster Cult reference to the title of this blog post, but I just couldn’t help myself. You’re welcome for putting that song in your head for the rest of the day!


For some reason, it’s the song I think of when helping clients figure out Required Minimum Distributions from their IRA accounts. That’s probably because the IRS rule was effectively designed to force all of the money out of your Traditional IRA accounts before you die. In my opinion, people always “fear” the rule too much, and it really isn’t that big of a deal. So, there is no need to fear the RMD (or reaper).


If you are not aware, anyone over the age of 70 ½ is required to take a certain amount of money out of his or her IRA account each year. The calculation is actually pretty simple for most people. The key number in the calculation comes from the Uniform Lifetime Table provided by the IRS. The number is essentially how many more years the IRS thinks you are going to live. The other number you need is the prior year-end balance (December 31 of previous year) of all your Traditional IRAs and Traditional 401(k)s (note that ROTHs are excepted).


The total balance becomes the numerator and the life expectancy number becomes the denominator. For example, if I am age 73 the IRS thinks I will live another 24.7 years. And, suppose I have $500,000 in Traditional IRAs. $500,000 / 24.7 = $20,243 that I will be required to withdraw (and pay taxes on) prior to the end of the calendar year. That represents about 4% of the total balance.


Here’s a free tip: as you get older, your life expectancy goes down (amazing, I know). So, the denominator will get smaller, and thus require you to withdraw a higher percentage each year. Good investment performance can help your IRA balance keep up with the requirement for a while, but once you get into your 80s, the percentage gets pretty steep.



A few other things to note:


  • The RMD is NOT a requirement to spend! You can simply pay whatever tax you owe on the distribution and re-invest the money into an investment account or other vehicle.
  • If you have multiple Traditional IRAs/401(k)s, you can take the required amount from any or all of your accounts. Typically, we would recommend exhausting the lower earning account (read: bank IRA CDs or savings) first in order to allow maximum growth in other accounts.
  • Beneficiaries of IRAs have different rules that they have to follow. Typically, money can move from spouse to spouse without much trouble or immediate tax. When the money flows to the next generation, things can get more complicated.
  • If you do not take your required withdrawals, the penalty is 50% of the amount you should have withdrawn. In my example above, that’s $10,121. OUCH!
  • There are some creative ways to donate to charities directly from your IRA. This is beyond the scope of this post, but good to look into for some.


The rule was designed so that the IRS would be able to tax your Traditional IRA dollars before you die. If the rule wasn’t in place, IRAs could essentially go on forever with an endless number of beneficiaries. Before you get too angry, remember that you enjoyed tax deductions on the money as you contributed over the years.


Believe it or not, Buck Dharma (the lead singer of Blue Oyster Cult) will have to start taking his RMDs in about 2 years. I can only assume he is neither fearing the requirement, nor is he fearing the reaper.

Me and my IRA beneficiaries

Categories : Financial Planning

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