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A Tax Penalty for I.R.A. Withdrawals Can Sneak Up on You

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Bill Van Sant, Managing Director for Univest Investments and Girard Partners, a Univest Wealth Management Firm, was featured in The New York Times

March 29, 2017
By: Ann Carrn, The New York Times

Time is running out for retirement savers who are required to take initial withdrawals from their Individual Retirement Accounts for 2016.

Savers who turned 70½ last year must take their first “required minimum distribution” — R.M.D., for short — by April 1, if they have not already done so. This year, that date falls on a Saturday — so quick action is required to avoid possible penalties, said Maura Cassidy, vice president for retirement at Fidelity Investments. Fidelity recommends completing transactions before the close of the market at 4 p.m. on Friday, she said, to be sure money is withdrawn by the deadline.

Ideally, people would start preparing for the distributions well in advance, as part of their planning for retirement spending, said Jean Setzfand, senior vice president for programs with AARP. “If you’re hitting your 70th birthday,” she said, “ this is something you should pay attention to.”

More people are bumping into the withdrawal requirement. About 3.3 million baby boomer Americans turn 70 this year, according to an AARP analysis of recent Census Bureau data.

It appears, however, that some retirement savers may be behind the curve. Fidelity Investments said that as of late December, 43 percent of the company’s investors who were eligible to take their first distribution from their I.R.A.s in 2016 had not yet taken the full amount. And 40 percent of those investors had not taken any of the mandated distribution.

Taking money out of retirement accounts can sometimes be a difficult adjustment for savers, after years of squirreling away money. But failing to take mandatory distributions on time can be costly. The penalty is 50 percent of the money you did not withdraw. So, for instance, if you were required to take out $10,000, but only withdrew $5,000, the potential penalty would be (ouch) $2,500. “It’s a big whack,” Ms. Setzfand said.

The withdrawals are required because retirement accounts enable people to save money on a tax-deferred basis — meaning taxes are postponed, rather than forgiven. The government will not let you defer taxes indefinitely, however. It aims to start collecting tax revenue at some point. Hence, the requirement to start making withdrawals, Ms. Cassidy said.

The requirement applies to most types of individual retirement accounts, except Roth I.R.A.s. (Roths have no required minimum distribution, because they are funded with after-tax money.)

The distribution rule also applies to workplace retirement accounts like 401(k)’s, but usually only if you have already retired, Ms. Cassidy said. If you are still working at the employer where your retirement plan is based, you probably do not have to begin withdrawing money until after you retire. But check with your employer or plan administrator.

After the initial distribution, the annual minimum withdrawal deadline shifts to Dec. 31 of each year. That means if you delayed taking your first distribution until April 1, you will have to make a second one in the same year, which, in some cases, may push you into a higher tax bracket.

To avoid missing annual deadlines and facing possible penalties, Ms. Cassidy recommends calculating the annual minimum amount and setting up automatic distributions from your retirement account, on a monthly or quarterly basis.

Here are some questions and answers about required minimum distributions:

What if I miss the annual withdrawal deadline?

Don’t panic, but do act as quickly as you can to distribute the necessary money, Ms. Cassidy said. You may be able to have the Internal Revenue Service waive the penalty. You can report the late withdrawal on Form 5329, which is filed with your federal Form 1040 tax return. Attach a letter, Ms. Cassidy advised, explaining that you forgot to make a required withdrawal — perhaps because of an illness, or other complication — but that you realized your mistake and have since made the required distribution.

How do I know how much to withdraw?

The required amount is generally based on a formula that factors in your account balance and your life expectancy, using the I.R.S. Uniform Lifetime Table. Your I.R.A. administrator may calculate the amount for you, or the I.R.S. offers a work sheet at the end of Publication 590B . Also, there are various online tools to help calculate the amount.

Can I make a charitable contribution using my required minimum distribution?

Yes. And it can be a smart way to use the money, if you don’t need it for living expenses, said Bill Van Sant, senior vice president and managing director at Univest Wealth Management, near Philadelphia. If you are 70½ or older, you can make a direct contribution of all or part of your required distribution from your I.R.A. to a charity, of up to $100,000 annually. The donation not only fulfills withdrawal requirements, but also avoids income tax on the withdrawal.

But be careful. To have the funds excluded from your taxable income, the money must go directly to the charity, rather than being withdrawn and, say, deposited into the saver’s checking account first. “It can’t touch their hands,” Mr. Van Sant said.

View the original at: https://www.nytimes.com/2017/03/29/your-money/a-tax-penalty-for-ira-withdrawals-can-sneak-up-on-you.html?_r=1

Securities and insurance products are offered through Univest Investments, Inc., member FINRA/SIPC and a licensed insurance agency. Investment advisory services are offered through Girard Partners, a Univest Wealth Management Firm. These affiliated companies are licensed subsidiaries of Univest Corporation of Pennsylvania. Products and services offered are not FDIC insured, are not a deposit of or bank guaranteed, and are subject to risks, including possible loss of any principal amount invested.

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