Required minimum distributions, or RMD's, affect people at the age of 70.5. It is the tax code's way of making sure funds from tax-deferred accounts, such as IRA's and 401K's are drawn down at this age, says Mark Miller, journalist with Reuters. The penalty is 50% of the amount that you were supposed to take and any interest on the delay of payment, adds Miller. The exception, he notes, is that for the first year, you can delay the RMD until April 1, but you still owe an RMD later that year, so you end up taking two in one year, which could have tax consequences.
Miller says this money comes out of one's account as ordinary income, so one needs to pay careful attention to what these RMD's do to their tax brackets. It could push one into a higher bracket or cause one to pay more of one's social security income.
There is a special formula, called the provisional income formula, to determine how much of your benefit is taxed, Miller says. It's determined by adding your adjusted gross income, any tax-exempt income and half of your social security benefits all together. He says that you are taxed if all of that exceeds $25,000 as an individual and $32,000 as a married couple.
To offset all of this, Miller says advance planning before one gets to their RMD is important. A lot of financial advisors will advise people to think about diversifying assets in terms of location in different accounts, well ahead of retirement, he adds.