You Only Have a Few Weeks to Avoid a Major Retirement Savings Penalty

Entering retirement with a large nest egg is a really great thing. The more savings you have, the more financial freedom you'll get to enjoy.

Now many people find that once they retire, they have no choice but to start taking withdrawals from their savings plans. That's because Social Security only provides a limited benefit, and often, it's not enough to cover living expenses in full.

But you might end up in a different boat. Maybe you've been able to hold off on tapping your nest egg because you've adopted a frugal lifestyle and are getting by between income from Social Security and a part-time job.

Unless you have your savings in a Roth IRA, you must remove a portion of your retirement plan balance each year once you turn 72 (though these rules are changing for those turning 72 in 2023 and beyond). It's called a required minimum distribution (RMD), and if you haven't taken your first one already, you should know that the deadline to do so is rapidly approaching.

How your first RMD works

RMDs generally need to be taken by December 31 each year. But you get a little more leeway the year you turn 72 in that you can take your first RMD by April 1 of the following year.

What this means, though, is that if you turned 72 in 2022 and haven't yet taken last year's RMD, you'd better get moving. You only have until April 1 of this year to remove that money from your 401(k) or traditional IRA. And if you don't take your RMD, the penalty will be steep.

Specifically, you'll lose 50% of your RMD in the form of a penalty. Those penalties were recently reduced to 25%, but the changes only take effect for the 2023 tax year, so it's likely that the IRS could seek to impose the old higher penalty.

So if you're looking at an RMD of $10,000 and you don't take any of it, you'll lose $5,000. Ouch.

Now the good news is that there's still a chunk of time between now and April 1, so if you've neglected your 2022 RMD thus far, there's no need to worry. But you should also make arrangements to take your first RMD now so you don't run into a time crunch.

You should also know that if you're taking an RMD from a traditional IRA or 401(k), you'll be liable for taxes on it. This isn't a penalty — it's the same taxes that apply to standard traditional IRA or 401(k) withdrawals.

Furthermore, if you turned 72 last year and are first taking your 2022 RMD now, it means you'll actually be looking at two RMDs this year. Remember, all RMDs subsequent to your first must be taken by December 31 each year. So you'll have to take a second RMD for 2023 at some point this year, which might add to your tax burden.

Don't get caught off guard

The good news is that the rules around RMDs are changing for the better. Beginning in 2024, Roth 401(k)s won't require them, and the age at which they'll start to kick in is getting later for younger savers.

But if you're already on the hook for RMDs or are nearing retirement and are worried about them, it's a good idea to read up on how they work and consult a tax professional for personalized advice. A professional may be able to help you navigate your RMDs and cope with the taxes involved.

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