Money Watch: Avoid tax penalty with 401k withdrawals

• For most people there is no compelling reason to take their RMD at any particular time of the year
• But it is very important not to miss the tax penalty deadline for your required withdrawal

Money Watch, a personal finance column that runs every Saturday, features a financial planner from the National Association of Personal Financial Advisors answering reader questions about saving, protecting and growing your money. To submit a question, e-mail USA TODAY personal finance reporter Christine Dugas at: dugas@usatoday.com.

Q: I am age 71 and I have a 401(k) plan with $500,000. I have ample funds for living expenses from Social Security and a pension. But now I will have a required a minimum withdrawal of about $21,000 a year from my 401(k) plan. What are the arguments for taking out the money every January? Or is there any reason to wait to take out the money in late December every year?

A: Conventional wisdom says that to maximize your long-term investment return you should defer withdrawals, staying invested as long as you can. Historically, most calendar years tracked back to 1926 have yielded positive stock market returns.

Assuming this pattern continues, if you consistently defer withdrawals to December instead of making them early in the year, on average you'll have a larger balance invested when the market goes up, enhancing your long-term investment returns.

Of course, this argument depends on the market following its long-term pattern and ending the year higher than it began. And there's no guarantee this will happen. With this in mind, I must say that I personally don't find the investment angle on the timing of your required minimum distribution (RMD) very compelling.

On the other hand, there is a very good reason not to wait too long to make your RMD. The IRS imposes a 50% penalty on the taxpayer who fails to make his RMD by the last day of the year. In your case that would be $10,500.

It's not a bad idea to give a wide berth to this draconian penalty by making your RMD distribution early enough in the year to give yourself plenty of time to catch any errors before the busy holiday season arrives. If you cut it too close and miss the December 31 deadline even once, you'll probably lose all of the possible investment gains that you hoped to capture by waiting till December each year.

Most 401(k) plan providers, such as Fidelity and Vanguard, can offer automatic distribution service to you on an annual, semiannual, quarterly or monthly schedule. They can calculate the amount of your RMD each year, as well as automatically distribute it.

If you want, you can double-check your provider's calculation with a free online RMD calculator, such one offered by FINRA, the securities broker regulator. If you have questions about which securities you should liquidate to fund your RMD distribution, or about how to invest the remainder of your portfolio, it's a good idea to visit with a financial adviser.

So, for most people there is no compelling reason to take their RMD at any particular time of the year. With this in mind, most people should simply take their RMD when it's most convenient for them to take it ... just make sure not to miss the deadline!

Thomas Posey, CFP, NAPFA-Registered Financial Advisor

Posey Capital Management, Houston

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