Traditional retirement accounts – including IRAs and 401(k)s – provide a tax break when you contribute and delay taxes on investment earnings until you make a withdrawal. However, the IRS won’t let you get away with delaying tax payments forever. That’s where Required Minimum Distributions [RMDs] come into play.
RMDs are minimum withdrawals you must make each year once you reach a certain age or after you inherit a retirement account. The rules surrounding when you must begin RMDs vary based on a few factors, and we’ll cover these different requirements so you can feel confident in your plan and avoid tax penalties.
When To Take RMDs from Your Traditional IRA or 401(k)
In most cases, Individual Retirement Accounts [IRAs] and employer sponsored retirement plans – like 401(k)s – have the same requirements for the age at which you must begin RMDs. That age is currently 73, though it has changed several times over the past few years.
Past RMD ages were:
- 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.
The age 73 requirement applies if you reached or will reach age 72 after December 31, 2022. The RMD age will further increase to 75 beginning in 2033, but this change will not impact those reaching RMD age before that time.
Exception to Age 73 for Workers With 401(k)s
If you are still working when you reach age 73, you can delay your first RMD from your current employer’s retirement plan until you retire. This exception only applies if you do not own more than 5% of the company, and it does not exempt you from RMDs for other accounts.
Timing of RMDs from Traditional IRAs and 401(k)s
Once you reach RMD age, you must begin distributions by April 1st of the following year. Each subsequent year, you must take your RMD by December 31st.
For example, if you turn 73 in 2026, you must take your 1st RMD by April 1, 2027, and your 2nd RMD by December 31, 2027. Each subsequent year, you must take your RMD by December 31st.
It is important to remember that the funds must leave the account by the deadline to satisfy your RMD – such as through the issuance of a check or an electronic transfer. If you do not have sufficient cash in your account and must sell investments to meet your RMD, then you need to account for settlement timeframes when planning your distribution. Most investments settle the business day following the trade date – known as T+1 – but you should check with your financial advisor for the details on your specific portfolio before relying on this rule of thumb.
Penalties for Late and Missed RMDs
If you don’t take your RMD by the deadline, you could be subject to a penalty of up to 25% of the missed amount. This penalty is reduced to 10% if you correct the mistake within 2 years.
Due to the significant penalty for missed RMDs, begin planning your distributions in advance of the deadline. Often, this includes speaking with your financial advisor about the amount you need to take, requesting a sale with plenty of time for settlement, and ensuring you have payment instructions on file to avoid delays.
When to take RMDs from Inherited Accounts
RMD rules for inherited accounts fall into two main categories – rules for accounts inherited from your spouse and separate rules for accounts inherited from anyone else. These requirements are further subdivided by the age of the person who left you the account at their passing.
Inherited account RMD rules changed with the SECURE Act in 2020, and we’ll summarize the current rules below. For more details and an overview of rules prior to this change, see our article How the SECURE Act Changed Inherited IRA Rules.
RMDs for IRAs Inherited from Your Spouse
Accounts inherited from your spouse are subject to the most flexibility in RMDs. Depending on your spouse’s age when they passed, you can choose from the following options to calculate your RMD.
If your spouse had not reached RMD age when they passed, you can:
- rollover the account into your own IRA.
- keep the account as an inherited IRA and delay distributions until the account owner would have turned 72.
- keep the account as an inherited IRA and take RMDs based on your life expectancy.
- keep the account as an inherited IRA and follow the 10-year rule (discussed below).
If your spouse had reached RMD age before they passed, you can:
- rollover the account into your own IRA.
- keep the account as an inherited IRA and take RMDs based on your life expectancy.
The ability to roll the IRA into your own account is a significant benefit for spouse beneficiaries. It allows you to combine your spouse’s retirement assets with your own and follow the RMD rules for an individual, which were discussed above.
If you want to keep your inherited assets separate from your own retirement funds, you also have the option to keep the account as an inherited IRA. These rules are similar to those that apply to a non-spouse beneficiary.
RMDs for IRAs Inherited from Someone Other Than Your Spouse
Accounts inherited from someone other than your spouse are subject to different rules based on whether you meet the criteria of an “eligible designated beneficiary.” You meet this definition if you are the spouse or minor child of the account owner, disabled or chronically ill, or an individual who is not more than 10 years younger than the original owner.
If you are an eligible designated beneficiary, you can:
- take distributions over the longer of either your life expectancy or the original owner’s life expectancy.
- follow the 10-year rule if the original account owner passed before reaching RMD age.
If you are not an eligible designated beneficiary, you must:
- follow the 10-year rule.
These rules apply to beneficiaries that are individuals. Beneficiaries that are trusts or other entities are subject to different rules, which you can explore on the IRS website.
The 10-Year Rule
The 10-year rule is an alternative method for RMDs that allows you to avoid annual distributions in some cases. If the account owner passed away prior to beginning RMDs, you are not required to take annual distributions, and the only requirement is to empty the account by the end of the 10th year following the original account owner’s passing. If the account owner passed away after beginning RMDs, you must take annual distributions AND empty the account by the end of the 10th year.
Timing of RMDs for Inherited Accounts
The RMD in the year of death is the account owner’s required distribution and it must be taken by December 31st. In the case where they passed prior to beginning RMDs, there is nothing to take in the year of their passing. However, if they had already begun RMDs, the estate is responsible for taking the final RMD and paying the taxes on the distribution.
After the year of death, you, the beneficiary, would begin taking RMDs from the inherited account, and these distributions would be required by December 31st of each year. Two exceptions to this requirement apply. First, if you are a spouse beneficiary who rolled over the account or chose to delay RMDs. Second, if you are a spouse or non-spouse beneficiary using the 10-year rule when the original account owner had not begun RMDs prior to their passing.
RMDs are one of the most confusing and misunderstood aspects of inheriting an account, and the same 10–25% penalties apply if you miss an inherited RMD as if you missed one from your own account. Due to the confusion surrounding RMD calculations and the steep penalties for missing them, be sure to consult an experienced financial advisor following inheritance.
What If You Don’t Need the Money from RMDs?
Many retirees use distributions from their retirement accounts to fund their lifestyle, but some people don’t need to take as much as the IRS requires them to. If this is the case in your situation, you have a few options.
- Plan a Roth Conversion in Advance. Roth retirement plans are not subject to RMDs, so you can convert Traditional assets to a Roth plan before reaching RMD age to avoid required distributions.
- Invest in a Non-Retirement Account. If you must take a distribution from your account, you can pay the taxes on the distributed amount and invest the remainder in a non-retirement account, such as a brokerage account. This strategy allows you to continue investing in the same products, just in a different type of account.
- Avoid Taxes with A QCD. A qualified charitable distribution allows you to give your RMD directly from your retirement account to a qualified charity and avoid taxes on the distribution if the transfer is done correctly.
Whether you plan to use RMDs to cover your expenses or help with your charitable aspirations, an experienced financial advisor is the partner you need to make these goals a reality. Discuss your situation with your advisor and they will guide you through the steps needed to minimize your tax liability and meet your unique financial goals.
Plan Your RMDs with Meld Financial
The calculation of RMDs and the varied deadlines can be confusing to tackle alone. If you have a retirement plan of your own or one you’ve inherited, discuss your options with the team at Meld Financial before you reach RMD age.
We specialize in retirement planning and have developed a comprehensive wealth management program called Financial Fingerprint®. This nimble plan brings together the most important aspects of your financial life – including RMDs from all your retirement plans. To learn more about Financial Fingerprint® or discuss your personal situation, contact a member of our team today.
