Required minimum distributions, or RMDs, are the minimum amounts a retiree must withdraw from their retirement account each year. Understanding the rules surrounding RMDs is essential to avoid facing a hefty penalty. The government wants you to prepare well for your retirement years.
To that end, Congress created tax-deferred retirement savings accounts to aid you in your investing endeavors. These include 401(k)s and IRAs that incentivize you to start saving early through tax deductions, so you can enjoy a comfortable lifestyle when you stop working.
Once you turn 72, however, the government wants you to start paying taxes on those funds in that (hopefully!) incredible nest egg you’ve accumulated through RMDs.
Essentially, all non-Roth accounts have required minimum distributions, plus the Roth 401(K). The whole point is to pay those taxes you owe on them finally. You paid your fair share of taxes when you initially contributed to your Roth IRA, so the IRS never forces you to pull from it. You can even leave it as a tax-free gift to an heir!
But more specifically, here is a list of all retirement accounts with RMDs:
Major changes were made to retirement rules when the Secure 2.0 act was passed at the end of December. These new changes see an age increase as to when RMDs must begin. As of 2023, the RMD age is now 73 years old.
For your first RMD, you have a bit more leeway. You can make your first withdrawal anytime before April 1st once you turn 73. For example, if you turn 73 in August 2023, you can make that first withdrawal on February 1st, 2024. You must complete all subsequent withdrawals before December 31st.
There’s a whopping 25% tax on any undrawn portions! For example, if your required minimum distribution for the year is 30,000, and you withdraw only $15,000, you will have to pay a 25% tax on the other $15,000! The IRS may consider any extenuating circumstances and reduce the tax penalty if they find those circumstances amounted to honest error and you sincerely attempt to correct the situation. In such a case, the IRS will reduce the penalty to only 10%.
For example, let’s say in January of 2022, you’re 74 years old with a distribution period number of 25.5. You had a $1,000,000 portfolio value on December 31st, 2021.
$1,000,000 / 25.5 = $39,215
Don’t forget, you then owe regular income taxes on that amount.
If you inherited your IRA, you must use the RMD of the deceased in the year of their passing. Subsequent years depend on your beneficiary status, i.e., disabled, surviving spouse, ill, etc. In the case you inherit an IRA, we highly recommend reaching out to an experienced estate and wealth manager.
Now, the minimum part of the required minimum distribution is just that, the minimum. Feel free to take out as much as you want, even 100% of it (if you’re willing to pay taxes on it!)! Unfortunately, by taking out more in one year, you won’t be able to reduce your RMD the following year. In fact, your RMD amount will only increase as your age expectancy decreases. The government would rather you pay taxes on those funds at a probable higher tax rate rather than endowing it to an heir or donating it to a charity where they would be distributed tax-free.
You must determine the Required Minimum Distribution for every individual IRA account you possess. You then have two options: withdraw the sum of all your RMDs from one IRA account, or take out the minimum from each IRA account. If you haven’t solidified your tax-deferred IRAs by the age of 72, you should consider doing so.
As for multiple 401(K)s, you must calculate the RMD for each account and withdraw the necessary amount from each account individually. As opposed to IRA accounts, you cannot remove that amount from a single 401(K) account.
If you’d like to keep your assets growing and not take RMDs, you can always convert to Roth, though you’ll have to pay taxes on any investments you convert. You also want to ensure that the conversion doesn’t bump you up a tax bracket. An intelligent tax strategy will allow you to convert just the right amount to keep you in a lower bracket.
As RMDs play into your tax obligation, consider donating a portion (or all!) of your RMD to charity (a pretty popular thing to do in the holiday season). Any portion of the RMD won’t be considered as income, potentially keeping you in a lower tax bracket.
Is your RMD coming up, or do you want to create an RMD optimization strategy beforehand? Just let us know – we are experts in not only portfolio management but also in tax planning. Just click the button below for a consultation!