If you’re turning (or have already turned) 73 this year and have a tax-deferred retirement account, you may or may not be privy to an important deadline coming up: April 1, 2025, otherwise known as the very last day you can take your first required minimum distribution (RMD).

Not familiar with RMDs? Fear not! In this post, we’ll cover how they work and how to calculate them so you’re better prepared for this important date.

How RMDs work

RMDs are the minimum amount of money one must withdraw from specific tax-deferred retirement accounts beginning at age 73 (increasing to age 75 in 2033).

More specifically, RMD rules apply to various employer-sponsored retirement plans—including 401(k), 403(b), profit sharing, and 457(b) plans—as well as traditional IRAs and IRA-based plans such as SEPs, SARSEPs, SIMPLE IRAs, and Roth IRAs (in the wake of the owner's death).

Those impacted are required to take their RMDs by December 31 of each year; however, a couple of options are available regarding the very first one. For example, those with a 73rd birthday in 2024 can do so by December 31, 2024 or April 1, 2025. If this applies to you, keep in mind you must take your second RMD by December 31, 2025 no matter which option you choose.

Note that you aren’t required to take RMDs from an employer plan if you are still actively working with the same—even if you’re older than the RMD age requirement.

How to calculate RMDs

You can generally divide the balance of all your retirement plans (as of December 31 of the previous year) by a life expectancy factor provided by the IRS to calculate your RMD.

To illustrate, let’s assume you have a traditional IRA with a balance of $500,000 as of December 31, 2023. We’d first locate your age within the IRS Uniform Lifetime Table and the corresponding “life expectancy factor,” which is 26.5 in this example (assuming you’ve already turned 73) but changes yearly. We’d then divide your IRA balance of $500,000 by 26.5 and get $18,867.92: your RMD for the year and the amount you must withdraw from your IRA by April 1, 2025.

Take note that if your spouse is the sole beneficiary on the account and more than ten years younger than you, you’d refer to the Joint Life and Last Survivor Expectancy Table instead of the Uniform Lifetime Table to perform this calculation—as the former factors in the age of both you and your spouse, resulting in a longer life expectancy and thus reducing your RMD.

Those with multiple IRA accounts, meanwhile, must calculate the RMD separately for each but can withdraw money from one or more IRA (e.g., the account with the lowest balance).

This rule is much different than if you have multiple qualified retirement plans or plans sponsored by employers, such as 401(k)s or 401(b)s. In this scenario, you’d be required to take your RMD separately from each account—meaning that if you own two 401(k) accounts, for example, you’d have two different checks or deposits.

Strategies to satisfy your RMD requirements

Several options to fulfill this need include:

·      Cash withdrawals: In this case, you’d sell enough shares of stock or funds to generate enough cash for your RMD. Just note, however, that mutual funds (which often comprise workplace plans such as 401(k)s and 403(b)s) are only bought and sold at the end of each business day—with transactions generally settling the next business day. It’s therefore best to work with a financial advisor when determining what to sell.

·      Charitable donations: You can donate your RMD money (up to $105,000 in 2024) to charity via a qualified charitable distribution (QCD), which reduces your income tax liability while giving back to your favorite charity.

·      In-kind transfers: With this option, you make an RMD distribution from your retirement account in the form of investments rather than receiving cash: meaning you can move your stock/investment from your tax-advantaged account into a taxable investment account—such as a brokerage account—without liquidating shares. While in-kind transfers are taxable, this strategy is sometimes useful when markets are down—as you’re paying income tax on securities of relatively low value and only capital gains rates on the future growth of the same.

How RMDs are taxed

Earlier, we mentioned that tax-deferred accounts (for which you’d made pre-tax contributions) are subject to RMDs. With Uncle Sam now eager to collect his fair share, RMDs are taxed as ordinary income at the same rate your salary and interest income (e.g., from a bank account or bond) are taxed.

Additional income can also potentially push you into a higher tax bracket, boosting taxes on your Social Security benefit and the cost of your Medicare premiums; so make sure you plan ahead! Note that taxes on in-kind transfers are calculated based on the value of the shares transferred at the time.

Finally, know you can withhold taxes at the same time you take your RMD to ultimately pay less later; while a federal minimum of 10% exists, you can elect to withhold a higher amount.

RMD penalties

If you fail to take the total amount of your RMD by the required deadline, you may face a hefty penalty and be liable for a 25% tax on the amount not withdrawn (though this penalty can be reduced even further (to 10%) if you correct it in a timely fashion by withdrawing the required amount and submitting an updated tax return on time). You can also seek help from the IRS to waive this penalty, but you’ll need a good reason to do so such as a severe illness or the assertion you had received lousy advice from a tax preparer or IRA sponsor.

In sum: how to calculate RMDs

While the methodology used to calculate your RMDs is relatively simple, figuring out which accounts to take them from and strategies to simplify/avoid them can get complicated quickly. Thankfully, a trusted financial advisor can help you cut through the clutter.

Still have questions about RMDs? Schedule a FREE Discovery call with one of our CFP® professionals.

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.