Limiting Required Minimum Distribution Costs
The IRS requires that funds be withdrawn from nearly all retirement accounts, including traditional IRAs, 401(k) plans, and SEPs. These withdrawals are known as required minimum distributions, or simply RMDs. Once a retiree turns age 70½, the withdrawals must be made annually. (Roth IRAs are notably exempt from this rule, and a retiree has until April 1 of the year after he turns 70½ to make the first withdrawal.)
The IRS does not specify how you should free up the cash to take the withdrawal, only that you actually take the money out. This lack of specificity provides you with some flexibility to limit transaction costs. This inaugural Retired Investor column discusses portfolio strategies for handling required minimum distributions.
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Determine Your RMD
The first step is to determine how much you are required to withdraw on an annual basis. This is essentially an annual liability for your retirement portfolio, and it will be the cash goal you need to reach each year. (Any cash balances above this amount can be reinvested back into the portfolio for future growth.)
Your required minimum distribution is determined by dividing the dollar value of your IRA or retirement plan assets as of December 31 for the prior calendar year by a life expectancy factor. Appendix C of IRS Publication 590 (www.irs.gov/pub/irs-pdf/p590.pdf) has three tables with these factors. The precise table to use depends on the beneficiary of the account.
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