Don’t Get Caught in This Tax Trap
Transcript
It’s tax time again – not my favorite time of year, but an essential part of being an adult in a civilized, developed country.
That’s how I rationalize the beating I take every year at the hands of the bureaucrats in D.C.
A group of people got into a political discussion – as seems to be the case in almost all situations now – at a recent neighborhood party. “Discussion” is the polite way of describing what happened. Things really got nasty.
And this nasty one was about taxes.
After a few minutes of the usual bantering, one member of the discussion threw up their hands, interrupted everyone and stated, “I love taxes. I think we should pay as much as possible.”
Talk about an awkward silence. I just walked away and got another drink.
In fact, it was the end of the entire discussion. Nobody really knew what to say after that outburst.
No rational person wants to pay more taxes. It makes no sense. Paying our fair share is one thing, but as much as possible? Give me a break.
One of the most annoying taxes that specifically targets retired people and is often a big surprise to many is based on RMDs, or required minimum distributions.
An RMD is the amount that you have to take out of your IRA, 401(k), Simplified Employee Pension (SEP) IRA or any other tax-deferred retirement account after you reach the age of 70 1/2.
Like all things the IRS does, it’s complicated. It has ins and outs and ups and downs that most non-tax experts could never understand. But it is the law, and if you don’t take your distribution on time, you can be hit with as much as a 50% penalty.
The simple part of the rule states that you must begin taking this RMD after you turn 70 1/2.
You are allowed to delay claiming the distribution until April 15 of the year after you turn 70 1/2 – but if you do, you also must take a second RMD by December 31 of that same year.
That means you would take two taxable distributions in one year, which means you would pay twice the taxes in one year. The IRS presents this option as if it’s doing us a favor. Thanks for nothing, guys.
I can’t give specific tax advice in this piece because I’m not a CPA or tax preparer, but why anyone would want to have two taxable distributions in one year is a mystery to me.
When I turn 70 1/2, which is just a few years away, I’m taking the distribution as required and paying my tax owed that same year on one distribution. I won’t take two the following year.
Now, maybe you feel the same way as that person at the neighborhood party who wants to pay as much in taxes as possible. If so, I’ll take two distributions in one year and double your tax.
I guess somewhere in this crazy world that makes sense, but not to me.
My only advice I’m allowed to give, which is the same I always give when I do a tax piece, is this: Just pay your taxes. You definitely don’t want to go round and round with the IRS, folks.
Good investing,
Steve