“What do you mean I HAVE to take withdrawals??” This is a question we hear a lot! Required Minimum Distributions, also known as RMDs are withdrawals that you need to make from your retirement account, such as a traditional IRA or 401(k) once you reach a certain age.

Why RMDs Matter The idea behind RMDs is simple: the IRS doesn’t want us to keep delaying taxes on our retirement funds forever. These mandatory withdrawals make sure that at some point, these savings count towards your taxable income.

How Are RMDs Calculated? The IRS uses your life expectancy and the previous year’s account balance to figure out your RMD. Starting at age 73 (and moving to 75 in 2033), you need to start taking these distributions. The formula? Divide your account’s year-end balance by a number from the IRS’s “Uniform Lifetime Table.” For those of you wondering why you had to take RMDs earlier than age 73, the Secure Act increased the RMD age to 73, although the QCD age did not change (for more on QCDs continue reading below).

Tax Implications of RMDs Remember, RMDs count as regular income and are taxed accordingly. This means they could bump you into a higher tax bracket depending on your total income for the year.

Important Points to Keep in Mind

  • Timing is Key: You’ve got until December 31 each year to take your RMDs. But for your first one, you can delay until April 1 the year after you turn 73 (or 75 post-2033). Just be careful – delaying might mean two distributions in one year, affecting your taxes.
  • Juggling Multiple Accounts: Got several IRAs? Calculate the RMD for each but feel free to withdraw the total amount from any of them. For 401(k)s and similar plans, though, you need to take RMDs separately from each account.
  • Avoid Penalties: Not taking your RMD or taking less than required? The penalty for missing an RMD is 25%, a reduction from 50% starting in 2023 thanks to the Secure 2.0 Act. If the missed RMD is taken within two years that penalty is reduced further to 10%. And here’s another helpful tip: if you had a valid reason for missing your RMD, you could potentially get a waiver by filing IRS Form 5329. This could save you from the penalty altogether, but it’s important to ensure that your reason aligns with IRS guidelines.

Minimizing the RMD Impact

  1. Roth Conversions: Shifting from a traditional IRA to a Roth IRA might be a smart move. Roth IRAs don’t require RMDs for the original owner, and withdrawals are usually tax-free. Doing this before RMD age can lower future RMDs, but remember, it’s a taxable event. See here for our article regarding Roth Conversions.
  2. Qualified Charitable Distributions (QCDs): Over 70½? You can donate up to $100,000 directly from your IRA to a qualified charity. This counts towards your RMD and isn’t taxable income – a great way to give back while managing taxes. Notably, QCDs are not allowed from employer sponsored plans so if you have an old 401k you may want to consider consolidation to an IRA. See here for our article regarding QCDs.

Special Note on Inherited IRAs It’s important to note that inherited IRAs follow their own set of rules, which aren’t covered here. So, keep that in mind if it applies to your situation!

Wrapping Up Getting your head around RMDs is a crucial part of retirement planning. Strategies like Roth conversions and QCDs can really help manage the tax impact. With tax laws always evolving, like the changing RMD age, it’s important to stay on top of your retirement account management. And remember, consulting a financial advisor is a great way to tailor strategies to your unique financial goals and situation. Let’s make the most of your retirement savings!

 

Babb Wealth Advisors, LLC does not provide legal, tax, or accounting advice. This article is for informational purposes only.