Required minimum distributions [RMDs] are minimum withdrawals that must be made annually from most pre-tax or inherited retirement accounts once you reach a certain age. The IRS requires these taxable withdrawals to ensure that retirement assets are used for income during retirement rather than becoming an indefinite tax shelter.
Who has to take Required Minimum Distributions?
RMDs are required on all traditional retirement accounts once the account owner reaches a certain age. These include Traditional IRAs, 401(k)s, 403(b)s, and other employer sponsored retirement plans.
Currently, RMDs are also required to be taken from Roth 401(k)s. However, the SECURE Act 2.0 eliminates RMDs for Roth 401(k)s beginning in 2025. Additionally, Roth IRAs are not subject to RMDs during your lifetime.
If you inherit a retirement account, you will be subject to RMDs and possibly a mandated timeframe for withdrawing these funds. These rules apply to all types of inherited IRAs and employer sponsored retirement plans, including Roth plans.
When do you have to start taking RMDs?
Several pieces of legislation have increased the RMD age in recent years. For this reason, when you must begin RMDs varies depending on your age when the new rules were implemented. The current RMD ages are:
- Age 70 ½ if you reached age 70 ½ before January 1, 2020.
- Age 72 if you did not reach age 70 ½ before January 1, 2020, but did reach age 72 before December 31, 2022.
- Age 73 if you reach age 72 after December 31, 2022.
The SECURE Act 2.0 included a provision to further increase the RMD age to 75 beginning in 2033. This will not impact retirees who began RMDs prior to that year.
You cannot delay IRA withdrawals past age 73, even if you are still working. On the other hand, you may be able to delay RMDs from your current employer’s retirement plan until you retire – if the plan allows it. However, this exception does not apply if you own more than 5% of the company.
You can delay your first RMD until April 1st of the year after you meet the age requirement. After that, you must take your RMDs by December 31st of each year. If you delay your first RMD until the April 1st deadline, both the first and second distribution must be taken in the same tax year. For example, if you reach age 73 in 2023, you can delay your initial RMD until April 1, 2024. In this case, both 2023 and 2024 RMDs would be taken in 2024 and taxable in that year.
In your second and subsequent RMD years, the required dollar amount must leave the account by December 31st. If your funds are invested in stocks, bonds, mutual funds, money markets or investments other than cash, remember to account for the settlement timeframe – the amount of time between placing a sell order and when those funds are available for withdrawal. For most assets, the settlement timeframe is the trade date plus two business days.
If you miss the deadline for an RMD or do not take the full amount, you could owe a penalty to the IRS. The SECURE Act 2.0 reduced this penalty from 50% to 25% of the missed amount. You should act quickly if you miss the deadline, because if you correct the missed RMD within two years, the penalty is further reduced to 10%.
RMDs on Inherited Accounts
Inherited IRAs, including Roth IRAs, have annual RMDs and are sometimes subject to the 10 Year Rule – a maximum amount of time you can leave assets in those accounts before distribution. If you inherited an account before January 1st, 2020, annual RMDs are calculated using the appropriate life expectancy table. If the original account owner passed away after December 31st, 2019, you are required to take annual distributions and to distribute the entire account’s balance within 10 years of inheritance.
After the inherited RMD rules were changed in 2019, there was some confusion about whether beneficiaries needed to take annual distributions during the 10-year drawdown period. The IRS clarified that annual distributions are required under the 10 Year Rule, but there was some leeway given for years 2021 and 2022 when the guidance was unclear. So, beneficiaries who inherited accounts after December 31st, 2019, must take annual distributions each year beginning in 2023.
The 10 Year Rule for Inherited RMDs
The 10 Year Rule was implemented to combat “stretching” of IRA’s that was done in the past. The old strategy attempted to minimize RMDs by passing tax advantaged retirement accounts to very young beneficiaries who would have smaller RMDs based on their longer life expectancy. This would “stretch” the length of time that assets could remain in the retirement account and maximize tax sheltered growth.
Exceptions to the 10 Year Rule for RMDs
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 original account owner, and disabled beneficiaries. In addition, beneficiaries who are minors are not impacted by the 10-year rule until they turn 18. If there was no individual named as beneficiary on a retirement account and the assets pass into an estate or trust, the length of time that assets can remain in the account is shortened to 5 years.
Calculation of RMDs
In the end, the calculation of RMDs is 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 account owners 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 whose spouse is not more than 10 years younger than him / her.
- Single Life Expectancy Table: For those who are the beneficiary of an account and inherited it before the implementation of the 10-year rule on January 1st, 2020.
Generally, RMDs as a percentage of the account balance increase with the age of the account holder, meaning that you will have to take out more money each year as you grow older.
You must calculate RMDs for each applicable account. However, you can aggregate the withdrawals from identical plan types. For example, if you own three Traditional IRAs, you must calculate the required distributions from each, but you can take the combined amount from any of the accounts. However, you cannot take a 401(k) RMD from an IRA or an IRA RMD from a 401(k) since these are different plan types.
Since RMDs are minimum withdrawals, you are free to distribute more than the RMD amount. However, if you do this, you forgo the main appeal of many retirement accounts – tax sheltered growth.
Strategies to Reduce the Tax Burden of RMDs
Distributions from traditional retirement accounts are treated as income in the year that they are distributed. Therefore, they are subject to federal income tax and possibly state and local taxes. Since most RMDs are taxable, these distributions need to be factored into your tax plan.
There are a few strategies that can reduce the overall burden of your RMDs. 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 and therefore the size of future RMDs.
Similarly, conversions to a Roth IRA can also help to minimize RMDs later in life. Since Roth IRAs do not have RMDs while the account owner is alive, converting pre-tax retirement funds to Roth can reduce the balance of pre-tax accounts and minimize RMDs. However, keep in mind that conversions from a Traditional IRA to a Roth IRA are taxable in the year that you convert.
Another way to minimize the tax liability of RMDs is to make qualified charitable distributions. When funds are paid directly from a retirement account to a qualified charity, they are not subject to income tax. The advantage in this case is that these distributions count towards RMDs but do not add to taxable income.
There are many other strategies that can help you balance tax advantages during your working years and retirement. An experienced financial advisor can help you create a plan to manage your tax liability and reach your retirement goals.
Plan for Retirement with Meld Financial
RMDs 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 dates and minimums so you can plan effectively. The experienced team of tax, legal, and investment professionals at Meld Financial can help you manage your RMDs and minimize the tax consequences of these distributions.
If you’re looking for help saving and planning for your retirement, contact a member of our team. We will help you develop your Financial Fingerprint™, our proprietary wealth management plan that is quick to assemble, easy to understand, and simple to modify as your circumstances change.
