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There's a reason retirement savers are often encouraged to choose a Roth retirement plan over a traditional one. Traditional IRAs and 401(k)s not only come with taxed withdrawals but also eventually require savers to take required minimum distributions (RMDs), which can be a hassle from a tax perspective.
RMDs start at either age 73 or 75, depending on when you were born, and they're due each year by Dec. 31. Failing to take an RMD on time can result in a 25% penalty, so missing the deadline can be an expensive mistake.
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The good news is that if you're not quite ready to deal with the tax headache of RMDs, the IRS allows you to defer your first mandatory withdrawal to April 1 of the year after you turn 73 or 75 -- whichever one represents your RMD age. The bad news is that taking advantage of that leeway could prove to be a big mistake.
You might think that deferring your first RMD makes sense because it allows you to delay a tax bill. But it could actually end up creating an even bigger IRS bill.
When you defer your initial RMD to April 1 of the following year, that year's RMD still applies. In other words, you'll have to take two RMDs that year -- one by April 1, and the second by Dec. 31.
If you have a large retirement account balance, two RMDs in the same tax year could lead to a gigantic IRS bill. Plus, you could face other consequences by having your income increase significantly.
If you're enrolled in Medicare, for example, and your income rises substantially, you could end up facing surcharges on your Part B and D premiums two years later. Two RMDs in the same year could also create a scenario where your Social Security benefits are subject to taxes, costing you money that way.
It's easy to see why delaying your initial RMD might sound appealing. But it's a move that could backfire on you in multiple ways.
Before you delay, run the numbers to see how taking two RMDs in the same calendar year might affect your taxes and overall finances. You may realize that you're better off taking your first RMD the year you turn 73 or 75, and that if you plan for that withdrawal accordingly, you can manage the taxes that ensue.
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This Seemingly Smart RMD Move Could Sorely Backfire on You was originally published by The Motley Fool
