When making plans for your retirement, there’s no doubt that you’re also looking into wealth protection. As such, you’ve probably encountered the term required minimum distributions (RMD) but you may not know what it means. Fortunately, we’ve placed all the vital details in this blog post — read on to find out more.
What Is a Required Minimum Distribution?
Required minimum distributions (RMDs) are an important component of creating an effective strategy for your retirement income — planning ahead of time can increase reinvestment and reduce taxes. Simply put, an RMD is the cash amount that needs to be withdrawn from a traditional IRA, SEP, SIMPLE individual retirement account (IRA), or employer-sponsored retirement plan by their owners or qualified retirees with retirement plans. The IRS requires account owners like yourself to start withdrawing RMDs at age 73.
Required Minimum Distribution Specifics
These amounts are usually kept at a minimum. The owner of the retirement plan account will need to make a withdrawal each year starting from the time they reach 73 years of age or (70 ½ if they reached this age before January 1, 2020). But if you have a 5% share in the business that supports the retirement plan or if the retirement plan account you own is an IRA, then your RMDs need to start once you turn 73, whether or not you’re retired.
Both IRA owners and those participating in retirement plans, including those who own SIMPLE and SEP IRAs, must take the right RMD from their account on time each year. Failure to do so will result in harsh penalties, which are discussed further below. If an IRA owner or the owner of a retirement plan account passed away before January 1, 2020, and was yet to begin their RMDs, the whole amount of their benefit would generally need to be distributed to their beneficiary.
However, the benefits will need to be provided either over the beneficiary’s life (provided it doesn’t start any later than one year after the death) or within five years of the owner’s death.
Owners of Individual Retirement Accounts or those who participated in defined contribution plans who pass away after December 31, 2019, are required to distribute their whole balance within 10 years according to the SECURE Act. An exception applies for the following:
- A child under the age of majority
- A surviving spouse
- A chronically ill or disabled person
- A beneficiary no younger than 10 years from the IRA account owner or employee
Keep in mind that the 10-year rule still applies whether the account owner dies at any time before or after the required beginning age. It’s also imperative that you understand how to avoid costly penalties, and how you can maximize your withdrawals, which are further explained below.
Recent Changes to RMDs
This year, the age by which owners must start taking their RMDs changed from 72 years to 73 years. As such, you’ll need to start withdrawing from your retirement account by April 1 following the year you turn 73 years old. This means that you’ll need to withdraw your RMD every year based on current RMD calculations.
Another change from the SECURE Act states that beginning in 2024, those who have a designated Roth 401(k) account will no longer need to take RMDs from these accounts over the course of their lifetime. This rule already applies to Roth IRAs.
How Required Minimum Distributions Work
Required minimum distributions work like a safeguard to protect against individuals looking to avoid paying their taxes through a retirement account. An RMD is determined using the retirement account’s last year-end fair market value (FMV) and dividing it by the owner’s life expectancy or the correct applicable distribution period. The IRS also has a spreadsheet that can help taxpayers get the right amount they need to withdraw.
In general, your plan administrator or account custodian will be able to calculate the right amount for you and report it directly to the IRS. There are a few qualified plans that allow select participants to defer the beginning of their RMDs to when they retire, even if they are older than 73 years of age. Those who qualify for this exception will need to discuss with their employees whether they’re eligible to get this deferral.
Generally, these exceptions apply to plans provided by the workplace or company that hired them, not from previous employers or IRAs. It’s also worth taking note that while an account holder will need to withdraw the RMD value, they can withdraw more than that. If you wish to withdraw everything inside your account during the first year, you are legally allowed to do so but you may be shocked by the tax bill.
Calculating Your RMDs
The custodian for your account will be able to discuss the RMD needed for each year but you may also do your own calculations to see how much you owe. If you do choose to do it by yourself, be sure to confirm that you have updated calculation sheets by visiting the IRS website, which will reflect any changes based on life expectancy. This is because different situations will use separate calculation tables.
For instance, an IRA account holder with a spouse who serves as the only beneficiary for the account and is over 10 years younger compared to the account owner will need a different spreadsheet than other kinds of account holders. On the other hand, a traditional IRA account holder will use an RMD calculation with three steps:
- Record your account’s balance since Dec. 31 of the year before.
- Look for the distribution factor that’s listed on the calculation tables according to your age as of your birthday during the current year. For a lot of people, this factor number will range from 27.4 to 1.9. This is because the factor number will go down as you get older.
- Divide your account balance by your factor number to get your RMD.
If you’re the original owner of the account, your RMD will be calculated by dividing the life expectancy according to the IRS Uniform Lifetime Table by the year-end account balance from the previous year. But if you’re married and your spouse is the only beneficiary while being over 10 years younger than you, you’ll need to use the IRS Joint Life Expectancy Table to get your RMD. Should your spouse be no more than 10 years younger than you, then the RS Uniform Lifetime Table is the right option.
Your RMDs will need to be taken from a tax-deferred retirement account, which includes the following:
- SEP IRAs
- Traditional IRAs
- SIMPLE IRAs
- Rollover IRAs
- Many 403(b) and 401(k) plans
Unless it was inherited, Roth IRAs have no RMDs.
There are a few deadlines that you will need to keep an eye on, which are:
- April 1 – This is the first deadline for the first RMD within the year you turn 73 years of age. Keep in mind, you don’t have to take the RMD until you retire or terminate your workplace plan.
- December 31 – This is the deadline for all of the following RMDs after the first.
Take note that if you choose to delay the first RMD until April, you must take two RMDs during the first year. You’ll still take the first one by April 1, and the second should be taken by December 1.
Make sure that you don’t miss any of your RMD deadlines — no matter your account type, the penalty from the IRS will be severe. Up to 50% of the amount can be penalized if you don’t take it on time.
When it comes to taxes, the IRS treats RMDs much like ordinary income, which means that withdrawals will be counted towards your total taxable income for the year. They will also be taxed at the appropriate individual federal rates for income tax and could also be subject to local and state taxes. If you’ve made after-tax contributions to a traditional IRA (or any IRA), you’ll need to calculate your RMD according to the total balance.
Just remember that any taxable income could be reduced in proportion to your contributions after tax. It’s also best to keep in mind that an increase in your income may nudge you up into a higher tax bracket. As a result, this may impact how much in taxes you need to pay for your Medicare or Social Security.
How Safe Wealth Plan Can Help
At Safe Wealth Plan, our team understands the complexities behind RMDs. We’re here to help guide you through the process so you can plan for your retirement and execute it perfectly.
We’ll provide you with a holistic view of your entire income retirement plan to show you just how long your cash will last. Schedule an appointment with our experienced and knowledgeable agents to create your customized wealth plan.