How to avoid tax penalties on your retirement savings

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It’s not just saving for retirement you need to worry about, but drawing down your money at the right time, too.

The IRS requires savers to make withdrawals from their retirement accounts starting at age 70½.

“They’ve allowed you to defer taxes, but they need to come collecting at some point,” said Arielle O’Shea, a retirement and investing expert at personal finance website NerdWallet.

The dreaded required minimum distributions, known as RMDs, apply to most individual retirement accounts, as well as work-based accounts such as 401(k) and 403(b) plans. One exception is the Roth IRA, to which after-tax contributions are made. However, inherited Roth IRAs are subject to the requirements.

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Your first mandatory withdrawal typically must be taken by April 1 after the year you’ve turned 70½. Following that, you’ll need to take them by Dec. 31 of each year.

You could have more time with your 401(k) if you’re still working and your employer allows it. In those cases, you don’t have to start drawing down your account until April 1 of the year following the one you retired.

“This break never applies to your IRA, even if you’re still working,” said Ed Slott, a retirement savings expert.

Figuring out how much you owe can be complicated. You divide your account balance at the end of the last year by a distribution period based on your age, O’Shea said.

For example, if you’re single and will be 70½ on Dec. 31 of this year, and you had an account balance of $100,000 at the end of last year, your required minimum distribution for the year is $3,650.

NerdWallet has a calculator on its website to help you figure out your RMD. Your financial advisor also can do so.

Another option: Your IRA administrator can typically calculate your RMDs and set up a distribution schedule, O’Shea said. “Take advantage of that,” she said. “It’s much easier to factor these RMDs into your income that way, and you’re not scrambling to meet the deadline — or risking forgetting.”

If you have multiple IRAs, you need to add them all up to determine your RMD, but you can usually take the required withdrawal from one account. However, if you have multiple 401(k) accounts, you typically have to make a withdrawal from each one, O’Shea said. And distributions from a 401(k) won’t satisfy your IRA distributions, Slott said.

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It pays to get it right: The IRS will tax you 50% on the amount you should have withdrawn but didn’t.

Your plan sponsor should also provide you with a Form 1099-R each year, said Katie Pehrson, senior wealth planner for Wells Fargo Private Bank.

“This form provides details on the distributions made from your retirement plans during the taxable year and should contain the information you need to report to the IRS on your personal income tax return,” Pehrson said.

What happens if you mess up?

You could potentially get out of that steep penalty by filing Form 5329 with your return, Slott said, and include a short explanation of why you missed your RMD.

But don’t let the grass grow, Slott said: “You must make it up as soon as you discover the error.”

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