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Required minimum distributions (RMD’s) are minimum withdrawals that must be made annually on most individual retirement accounts once the beneficiary reaches a certain age. These apply to most individual retirement accounts, but there are some exceptions such as a Roth IRA whose contributions are already taxed.
RMD’s are required by the IRS because they can help prevent multiple generations of tax-free growth on retirement accounts. Negligence of this law can result in a penalty of 50% of the required minimum distribution’s amount.
When do you have to start taking Required Minimum Withdrawals?
RMD’s become necessary the year after the account holder turns 72, or 70 ½ if the account holder turned 70 ½ before December 31, 2019. The first RMD must be made by April 1st of the year following the age requirement, with all subsequent deadlines being December 31st. This includes the year of the first RMD on April 1st. If the first RMD is delayed, both the first and second distribution will count for the same tax year. RMD’s for 2020 were recently suspended by the CARES Act in response to the COVID-19 Pandemic.
For beneficiaries who inherited an account before January 1st, 2020. These individuals must take RMD’s from the inherited account based on their life expectancy factor – those calculations are detailed below.
The “10 Year Rule” for RMD’s
Another important detail you should know is beneficiaries of retirement accounts with owners who passed away after December 31st, 2019, are required to distribute the entire account’s balance within 10 years of inheritance. This rule was designed to combat “stretching” of IRA’s that was done in years past. The old strategy attempted to minimize RMD’s by passing accounts on to very young beneficiaries, thus maximizing tax sheltered growth.
Exceptions to the “10 Year Rule” for RMD’s
There are some exceptions to the “10 Year Rule”, such as beneficiaries who are spouses, those who are within 10 years of age of the account owner, and disabled beneficiaries. In addition, beneficiaries who are minors are not impacted by the 10-year rule until they turn 18.
Calculation of RMD’s
In the end, the calculation of RMD’s are the responsibility of the account holder. The IRS provides multiple tables to assist individuals in their calculations, and the amounts are based on their circumstances. The three tables that work for most people are:
- Joint and Last Survivorship Table: For those whose spouse is the sole beneficiary of the account and his/her age is more than 10 years younger than the account owner.
- Uniform Lifetime Table: For all account owners whose spouse is not the sole beneficiary or is not more than 10 years younger than him/her.
- Single Life Expectancy Table: For those who are the beneficiary of an account and received it before the implementation of the 10-year rule on January 1st, 2020
Generally, RMD’s as a percentage of the account increase with the age of the account holder. The calculation and withdrawal of RMD’s must be made on each account in the owner’s name based on the calculations detailed above. Since these withdrawals are the minimum, any amount above the RMD can also be legally withdrawn. However, one then forgoes the main appeal of many retirement accounts, tax sheltered growth.
Are there strategies to reduce the tax burden of RMD’s?
Distributions of any kind from retirement accounts, unless it comes from an after-tax contribution account like a Roth IRA, are taxable income for the year that they are distributed. They are subject to federal income tax, and possibly state and local taxes. Those who are working after they turn 72 or have other sources of income should be careful as these distributions need to be factored into their tax plans.
There are a few strategies that can reduce the overall burden of your RMD’s, but each would be specific to a particular situation. For example, one strategy is to begin taking contributions as early as possible without penalty, typically 59 ½ years old. This will decrease the overall size of the account come retirement, and therefore the size of the RMD if the owner isn’t already retired.
Another is to make qualified charitable distributions. These are distributions that come directly from a retirement account and go straight to a qualified charity. The advantage is that these count towards RMD’s but are not taxable.
RMD’s are an inevitable part of saving for retirement in a tax-advantaged account. Regardless of whether you’re an account holder or a beneficiary, it is important to know the important dates and minimums so you can plan effectively. Working with a qualified team of financial professionals can help alleviate these stresses and minimize potential tax burden. If you’re looking for help saving and planning for your retirement, contact a member of our team at Meld Financial. Our team of wealth managers consists of financial, legal and tax professionals who will help you develop your Financial Fingerprint™, our proprietary system that guides your retirement plan.