Over the years, a handful of changes have been made to the IRS-mandated required minimum distribution (RMD) rules. When someone is not familiar with how RMDs work, it can be easy to miss a required step or misunderstand the requirements.
This article provides an overview of how RMD rules generally work today and highlights key concepts that often apply across different situations.
When Are RMDs Required?
For those who did not inherit accounts, the starting age for RMDs is 73 for many current retirees, and it is scheduled to increase to 75 beginning in 2033 (under SECURE 2.0). After that point, a minimum amount is generally withdrawn each year by the end of the calendar year.
For the first year an RMD applies, the rules are slightly different. The IRS typically allows a one-time delay, giving additional time to take that initial distribution by April 1 of the following year.
While you are allowed to delay your first RMD, doing so can have unintended consequences, including being required to take two RMDs in the same calendar year, which may increase your taxable income.
If a required minimum distribution is not taken in full, the portion that was missed is generally subject to an additional tax. Under current rules, the tax rate may vary depending on when the mistake was corrected.
To document the oversight with the IRS, you will need to file an additional tax form along with your standard federal tax return for the year in which you missed the RMD.
How Are RMDs Calculated?
Your RMD is not a stagnant number; it will change every year based on your year-end account values.
You will need to calculate your RMD annually by applying the appropriate IRS life expectancy table, which for many account owners is the Uniform Lifetime Table. This information has normally been found on the IRS Required Minimum Distribution FAQ page.
Not All Accounts Require an RMD
Here is a piece of good news: RMDs generally apply only to non-Roth retirement accounts. These typically include traditional and rollover IRAs, as well as many employer-sponsored retirement plans such as 401(k) and 403(b) accounts.
Individuals who do not own these types of accounts and are not beneficiaries of inherited retirement accounts generally do not have RMD requirements.
If you are not sure whether one of your accounts are subject to RMD rules, it may be helpful to reach out to your financial planner for guidance. Being a Spokane, WA financial advisory firm, we serve clients both locally and nationally as we help determine RMDs as part of their retirement income plan.
A caveat for inherited retirement accounts: If you have a retirement account that you received as an inheritance, you may need to take an RMD from it.
However, it will depend on certain factors; for example, if you are the original owner’s spouse, the rules may be different compared with a non-spouse heir. Here again, consulting with your financial planner is key.
Optimizing Your RMD
Although RMDs are a fact of life for most IRA owners, there are still ways to make the most of the situation. Looking at RMDs in advance can help open the door for beneficial financial planning strategies to make RMDs work more for you.
Plan for taxes: Required minimum distributions are generally taxed as ordinary income at the federal level and may also be subject to state income taxes. Because of this, taxes are often an important consideration when RMDs are taken.
In some cases, account holders choose to have taxes withheld at the time of the distribution rather than paying them later. You can work with your account custodian to arrange this when making the distribution request.
Moreover, if you expect a higher-than-usual tax bill for any reason, you can consider your RMD as a means for covering the bill.
Instead of withholding a certain percentage, as stated in the scenario above, you would simply ask the account custodian to make a redemption of a specific dollar amount and send the proceeds directly to the IRS. Any remaining portion of the required distribution is generally paid to the account holder as income.
Qualified charitable distributions: If you are charitably inclined, current rules allow certain IRA distributions to be made directly to qualified charities, which the amount given can then be excluded from taxable income.
This is made possible through the IRS Qualified Charitable Distribution (QCD) rule, which is available starting at age 70½ and may also count toward your Required Minimum Distribution (RMD).
The rule stipulates that a distribution made from a qualified account to a charitable organization is tax-exempt if the distribution is made payable directly to the qualified charity. These distributions normally have annual limits set by the IRS.
This provision can become especially relevant once required minimum distributions apply. Since money is required to leave the account either way, you might as well take the opportunity to support a charitable cause and reduce your tax bill in one fell swoop.
Alternatives to income: Some account owners will find they don’t necessarily need the RMD as personal income. Although a simple concept, it’s important in these scenarios to remember you are not required to redeem the funds to your bank account for spending.
You can alternatively transfer the funds into a non-qualified brokerage account. This way, the money can continue working for you by staying invested. However, any amount transferred into a non-qualified brokerage account will still be treated as taxable income.
Still Working?
If you are subject to RMDs, but still employed, the employer-sponsored retirement plan associated with your job is normally not subject to the RMD rule.
This may prove valuable if the plan allows for incoming rollovers; you may have the option to consolidate other RMD-subject retirement accounts into your current employer’s plan, thereby reducing your RMD responsibility even further.
It’s important to note that required distributions themselves cannot be rolled over, so any RMD must be taken before moving remaining eligible assets.
It should be mentioned that RMD deferral commonly applies to only those working for the entirety of the calendar year and who do not own more than 5% of the business.
Conclusion
Calculating required minimum distributions each year can feel repetitive, but it remains an important part of managing retirement accounts.
However, by applying a little effort and perhaps coordinating with your financial planner, you can create an efficient personal system for staying on top of these annually that also helps you maximize your financial plan.
Schedule a complimentary insight meeting to discuss your situation and how we may be able to help.