Retirement accounts offer tax benefits that help your savings grow, but eventually, you have to start withdrawing from them, a process that begins with Required Minimum Distributions (RMDs).
Here are the rules, timelines, and penalties associated with RMDs, ensuring you’re prepared for this crucial part of retirement planning.
What is a Required Minimum Distribution?
An RMD is the minimum amount the IRS requires you to withdraw from certain retirement accounts each year, starting when you reach a specific age. This withdrawal rule applies to most tax-deferred accounts like Traditional IRAs, SEP IRAs, SIMPLE IRAs, and 401(k) plans.
Since these accounts are funded with pre-tax dollars, the IRS requires withdrawals to ensure taxes are paid on the funds.
Why Do RMDs Matter?
RMDs can have a significant impact on your tax planning. These distributions are considered taxable income, which could push you into a higher tax bracket or impact other aspects of your financial situation, like Social Security or Medicare premiums.
Understanding when and how much to withdraw can minimize the tax hit and maximize your retirement savings.
When Are You Required to Start RMDs?
You must take your first required minimum distribution for the year you reach age 72 (73 if you reach age 72 after Dec. 31, 2022). However, you can delay taking the first RMD until April 1 of the following year. If you reach age 72 in 2022, you must take your first RMD by April 1, 2023, and the second RMD by Dec. 31, 2023.
If you reach age 72 in 2023, your first RMD for 2024 (the year you reach 73) is due by April 1, 2025.
Delaying your RMD allows you to manage taxes if your income changes, but it can also mean taking two RMDs in one year, which may lead to a larger tax bill. Although each situation is unique, some find that spreading RMDs over multiple years helps them maintain a lower tax bracket.
Keeping track of your RMD start date is critical because missing an RMD can lead to steep penalties.
How to Calculate Your RMD Amount
Your RMD is based on your account balance and a life expectancy factor provided by the IRS.
To calculate, take the account balance as of December 31 of the previous year and divide it by your life expectancy factor from the IRS’s Uniform Lifetime Table. If your spouse is more than ten years younger and the sole beneficiary, a different table applies, which can reduce your RMD amount.
While the calculation might seem straightforward, it can become complex if you have multiple accounts or a diverse portfolio. Consider working with a financial advisor to ensure accuracy and explore tax-efficient strategies for managing RMDs.
Which Accounts Are Subject to RMDs?
RMDs apply to all tax-deferred retirement accounts.
Roth IRAs, funded with after-tax dollars, are not subject to RMDs for the original account owner. Designated Roth accounts in a 401(k) or 403(b) plan are subject to the RMD rules for 2022 and 2023. However, for 2024 and later years, RMDs are no longer required from designated Roth accounts.
What Happens If You Miss an RMD?
Missing an RMD can result in one of the most severe penalties in the tax code. Until recently, the penalty was 50% of the amount not withdrawn. The SECURE 2.0 Act reduced the penalty to 25% and dropped it to 10% if corrected within a specific timeframe.
To avoid these costly fees, consider setting up automatic withdrawals or working closely with an advisor to keep track of deadlines.
Strategies for Managing RMDs Tax-Efficiently
Careful RMD planning can help mitigate the tax impact. Here are some strategies that can work well:
- Roth IRA Conversion: Converting a portion of your traditional IRA to a Roth IRA before RMDs start can reduce future RMDs since Roth IRAs are not subject to RMDs for the account owner.
- Qualified Charitable Distributions (QCDs): If you’re charitably inclined and age 70½ or older, QCDs allow you to direct up to $100,000 per year to qualified charities directly from your IRA, bypassing income tax. QCDs can satisfy all or part of your RMD, providing tax savings and fulfilling charitable goals.
- Withdrawal Coordination with Other Income: By coordinating RMDs with other income sources, you may avoid pushing yourself into a higher tax bracket. For instance, staggering withdrawals from retirement accounts over several years can balance your income and reduce taxes on Social Security.
- Consolidate Retirement Accounts: Managing RMDs across multiple accounts can be complex. Consolidating accounts into one IRA simplifies tracking and calculating RMDs, though consolidation depends on your unique investment goals and advisor’s input.
How to Handle RMDs for Multiple Accounts
If you have multiple IRAs, you can calculate your RMDs separately for each account and take the total amount from one or more accounts. This flexibility does not apply to 401(k)s.
Special Considerations for Inherited Accounts
The rules for inherited retirement accounts depend on your relationship with the original account holder and when the account was inherited.
If you inherited a retirement account as a non-spouse beneficiary, you typically have ten years to fully distribute the funds under the SECURE Act. Spousal beneficiaries may delay distributions until the account owner has been required to begin their RMDs or can roll the assets into their retirement account for more favorable RMD treatment.
Final Thoughts
Proper planning for RMDs can minimize taxes, keep income steady, and ensure compliance with IRS rules.
Meeting RMD deadlines and understanding your options for handling withdrawals can make a significant difference in preserving your wealth. By exploring tax-efficient strategies like Roth conversions and charitable distributions, you can take a proactive approach to retirement planning that aligns with your financial goals.
