Once you reach a certain age, the government requires that you start drawing down the assets in certain types of retirement accounts via withdrawals that meet your required minimum amount, or potentially face a stiff penalty. This withdrawal is called a required minimum distribution, or RMD. Here are the things retirees and soon-to-be retirees should know about RMD rules, including recent changes due to the SECURE Act and the SECURE 2.0 Act.
Common RMD mistakes to avoid
First, taking the RMD is important because there is up to a 25% penalty associated with taking the incorrect amount or not taking the distribution at all. Generally, RMDs are considered taxable income when taken from tax-advantaged retirement accounts like traditional IRAs and 401(k)s. Roth IRAs and 401(k)s (beginning in 2024), however, don't require RMDs. Depending on the situation, it might make sense to work with a professional to determine how to best draw down certain retirement accounts before RMDs are required. Learn more ways to potentially reduce RMDs by reading this article on RMD tax strategies.
It's also important to update your retirement account beneficiary designations. Having outdated beneficiary designations, or not having any, may result in assets not being distributed according to your wishes.
Understanding RMD rules
How much do I need to withdraw?
RMDs are based on the age of the accountholder and the value of the account on Dec. 31 of the previous year. Worksheets and tables are available to help you understand your obligations. Your RMDs should be calculated each year based on your account balance at the end of the previous year, your current age, and your life expectancy.
Once again, realize that it's important to plan these annual distributions if you want to avoid paying penalties and excess taxes.
Exceptions to RMDs
A Roth IRA has no RMDs during the owner's lifetime because the money used for contributions has already been taxed. For tax years up to 2023, Roth 401(k)s are subject to RMDs, however, this changes in 2024 due to SECURE 2.0 Act, from 2024 onward Roth 401(k)s will no longer need to take RMDs.
RMDs and inherited retirement accounts
When the retirement account owner dies, inherited IRAs may also be subject annual RMDs. There are different rules governing RMDs from inherited accounts, based on the type of beneficiary you are, including whether you're a spouse, minor child, or sibling. There are various choices available, including lump-sum distributions, funds transfers and other choices, based on the type of beneficiary you are. Review the specific tax requirements before taking distributions from an inherited IRA.
How do RMDs impact your taxes?
RMDs from a tax-deferred retirement account, such as a traditional IRA, are usually treated as ordinary income in the year the distribution is received. If you made after-tax contributions to the retirement account, a portion of the RMD may be non-taxable. Review IRS Form 8606 to calculate how much of your RMD would be taxable. The taxable portion of the RMD will be added to all your other income for that year and taxed based on your tax bracket.
Do RMDs impact Social Security and Medicare?
RMDs generally increase an account owner's taxable income. Certain Social Security and Medicare calculations can be impacted. For example, a portion of Social Security benefits can be taxed for those whose RMDs push them above certain income thresholds. Additionally, those with higher incomes might pay higher Medicare premiums.
What is the deadline to take the RMD?
Under the old rules, individuals who turned 72 in 2022 or earlier, are subject to annual RMDs. Beginning in 2023, the RMD age changed to 73. The first RMD should be taken by April 1 of the year following the accountholder's birthday. Some experts suggest taking the first required distribution in the year that the accountholder turns 73 to avoid having two taxable RMDs in the same year.
In the past, the RMD penalty was 50% of what the accountholder should have taken, with some provisions to have the penalty waived. Since SECURE 2.0, the penalty has been reduced to 25% and possibly 10% if the issue is rectified in a timely manner.
What to do with an RMD if it's not needed for living expenses
For those who must take distributions, but aren't dependent on them for regular living expenses, here are a few considerations on how to apply the funds:
- Reinvest into a taxable account. This can provide income later, without RMD requirements. The funds can grow for heirs or be used at a later date. However, there might be a transfer fee, and it's important to be aware of potential tax consequences.
- Help grandkids cover education expenses. Grandparents can contribute to a 529 plan—up to $17,000 per year per child in 2023—without incurring federal gift taxes.
- Increase charitable giving. It's possible to make a qualified charitable distribution (QCD) to qualified charitable organizations. These contributions can count toward the RMD but aren't considered taxable income. This can be a potential strategy to reduce the taxes associated with RMDs.
- Fund a Roth IRA. For accountholders with earned income, the money could be contributed to a Roth IRA.
This document is a summary of information found in various federal tax publications and websites, including: the Internal Revenue Service (IRS) website, and IRS Publication 559. For additional details and information, please consult the IRS website or work with a tax professional to ensure all rules and limitations are considered.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own situation before making any investment decision.
This information is for educational purposes only and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, you should consult with a qualified tax advisor, CPA, Financial Planner, or Investment Manager.
Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5- year holding period. In addition, earnings distributions prior to age 59½ are subject to an early withdrawal penalty.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.0923-3P69