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Here's the trickiest IRA tax trap retirees need to avoid

The new work trend: "Unretirement"

Retirees, take note. If you've attained age 70-1/2, or will in the near future, you'll want to be proactive in managing your required minimum distributions (RMD) from your IRA or 401(k) plan. That's because when stock prices drop -- as they certainly did in 2018 -- it can create a trap for unwary retirees who wait until the last minute to make their annual minimum withdrawals.

Let's take a look at some steps you can take to protect yourself from this unpleasant surprise.

How RMDs work

The RMD rules apply to the following accounts: deductible IRAs, SEP-IRAs, SIMPLE IRAs, deductible and Roth 401(k) plans, 403(b) plans for nonprofit organizations and 457(b) plans for government employers. Note that Roth IRAs aren't subject to the RMD rules, but Roth 401(k), 403(b), and 457 plans are. (If you have a Roth version of one of these plans and want to avoid the RMD rules, you'll need to roll over your account to a Roth IRA.)

If you participate in any of these accounts and have attained age 70-1/2 by the end of a calendar year, you'll need to make a minimum withdrawal by Dec. 31 of that year and include it in your taxable income. You have a one-time exception for the first year the rules apply to you -- that's the only time you can wait until April 1 of the following year to make your withdrawal.

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Note that If you have multiple IRAs subject to the RMD rules, you're allowed to determine the total amount you must withdraw and take it from just one IRA. However, you can't do that for your 401(k), 403(b) and 457 accounts. In those cases, you must make the minimum withdrawal from each account.

The amount of your minimum withdrawal is determined at the beginning of the calendar year. To find out what it will be, you divide your account balance at the end of the previous year by your life expectancy, as dictated by IRS Publication 590-B. As a practical matter, you apply a percentage to your year-end account value to determine the minimum amount you need to withdraw. To help you calculate the amount, check with your IRA or 401(k) administrator, who might host a free online RMD calculator, or try FINRA's online calculator.

You don't want to violate the RMD rules -- the IRS applies a 50 percent penalty on any shortfalls on the amount you withdrew during the year. Something else to note: You're allowed to withdraw more than the RMD without any penalty.

While you have the entire calendar year to make withdrawals from your account, many retirees wait until the last minute in December to withdraw the minimum amount. And that's where trouble lurks.

A trap for the unwary

Many retirees who waited until December 2018 to make their withdrawals for last year might have been surprised by the dollar amount they had to take out to comply with the RMD rules. That's because even though the stock market dropped significantly in 2018's last few months, very likely lowering their account balances, their withdrawal amount was based on the account value as of Dec. 31, 2017. This amount may have been higher because it reflected robust returns during 2017.

The result: Some retirees were likely forced to sell depreciated assets to comply with RMD rules.

In previous years, retirees who waited until the last minute to make withdrawals were often rewarded because the S&P 500 experienced nine straight calendar years of positive returns. But that winning streak came to an end during 2018, and some retirees who waited to make their withdrawals wound up whipsawed.

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It's important to realize that you have, at most, a one-year investment horizon with the amount of your withdrawal for a calendar year. Conventional investment wisdom calls for conserving principal when you have a short investment horizon. If you don't want to be exposed to market risk on your withdrawal amount, you could take the money out shortly after the beginning of the calendar year and deposit it in your checking or savings account. That way you'll have it available to spend during the year, without worrying about whether the stock market will decline as the year progresses.

Some financial institutions will allow you to put your RMD payment on autopilot and pay it according to a schedule that you specify in advance. This can help prevent costly mistakes if you forget to trigger the payment.

Of course, you could argue that over the long run, you would still be better off keeping your accounts invested as long as possible. After all, had you always waited until December to make your withdrawals, you would have had nine straight years in which to enjoy positive returns. A negative experience in 2018 would have been the "price" you paid for your strategy to wait.

And that's the main point here: No matter what you do, make a conscious decision regarding your investments, whether you want to withdraw your RMD amount as soon as possible to avoid being whipsawed or you accept an occasional setback for keeping your savings invested as long as possible.

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