The closer you are to retirement, the more you’ll hear about required minimum distributions (RMDs): the minimum amount of money you’re required to withdraw from specific tax-deferred retirement accounts beginning at age 73 (climbing to age 75 in 2033 for those turning 74 after December 31, 2032). In this post, we’ll answer the most common questions to help you better prepare for RMDs.

Retirement accounts that require RMDs

If you’re wondering why RDMs are mandated, know this policy is in place so that the IRS can collect taxes on these accounts—as all contributions you’ve made are tax deferred, using pre-tax money. With this in mind, RMD rules apply to all employer-sponsored retirement plans including 401(k), 403(b), profit sharing, and 457(b) plans. The mandate also applies to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs, as well to beneficiaries of Roth IRAs.

How RMDs are calculated

You can generally divide your retirement plan balance (as of December 31 of the previous year) by a life expectancy factor to calculate your RMD. While the IRS’s Uniform Life Table is the most common method used to obtain one’s life expectancy factor, know you may be required to use other tables instead based on your marital status, beneficiaries, and spouse's age.

To illustrate, let’s assume you’re 78 years of age, the balance of your IRA was worth $250,000 at the end of last year, and your spouse is 75 years old/your account's sole designated beneficiary. In this case, we’d use the Uniform Life Table—which indicates a distribution period of 22 years based on your age—to calculate your RMD. You must therefore withdraw at least $11,636.63 ($250,000 divided by 22) during this year.

Note that the distribution period on the charts decreases each year, meaning your RMDs will increase accordingly.

RMDs and taxes

If all of your contributions were tax-deductible, your required minimum distributions are then taxed as ordinary income (per the same rate as your taxed wages, interest income, and short-term capital gains) in the year you take them.

Penalties for missing the RMD deadline

Those impacted are required to take their RMDs by December 31 of each year. However, a couple of options are available with respect to taking your very first RMD. For example, if you turn 73 in 2023, you can either do so by either December 31, 2023 or April 1, 2024. Just know that no matter which option you choose, you’ll need to take your second RMD by December 31, 2024.

Should 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. Note that 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. Furthermore, you can seek help from the IRS to waive this penalty, but you'll need a good reason: such as a severe illness or assertion that you had received lousy advice from a tax preparer or IRA sponsor.

You can take distributions any way you’d like

The manner in which you take your distributions is entirely up to you—provided you meet the deadlines, that is! Want to do so on a monthly or quarterly basis? You can! You even have the option of an annual (lump sum) distribution.

Keep in mind there are various pros and cons associated with taking distributions periodically rather than annually, depending on your circumstances. For example, if you opt for an annual option, you could potentially pay higher estimated taxes if you own a business or generate self-employment income and pay taxes quarterly. However, a lump sum option could mean more (or reduced) growth for your account since you’re leaving the money in your account for a longer period of time.

You can reinvest your required minimum distribution

Since the government simply wants to make sure you’re paying taxes on this money, you can spend or reinvest your RMD withdrawals as you see fit (other than reinvesting the money in a tax-advantaged account). That said, you may be able to reinvest your RMD in a Roth IRA provided you have earned income—in an amount equal to or greater than—the RMD amount you contribute to the Roth IRA (and are eligible based on account income limits).

You can withdraw more than you need

If your circumstances dictate you withdraw more than the minimum amount required, you can in fact do so! However, remember this may involve tax implications as your withdrawal will be taxed as ordinary income (i.e., the same rate as any wages, interest income, or short-term capital gains).

You can’t mix and match account types to meet your RMDs

Let’s assume you own multiple IRAs as well as a 403(b). In this scenario, it’s perfectly ok to aggregate your RMD amounts for all of your IRAs and take a single distribution from just one of the accounts—rather than a distribution from each. What’s not allowed, however, is aggregating your IRA and 403(b) amounts and taking a single distribution from just one of these accounts.

Note that if you have multiple 401(k) plans from various employers, you cannot aggregate them as you can with IRAs. You’ll therefore need to calculate an RMD for each plan and take that amount from each account.

You and your spouse can’t combine RMDs

Individual ownership is required for retirement accounts; you therefore cannot take an RMD from your spouse’s account to satisfy yours, as doing so would result in the IRS claiming you did not fulfill your RMD requirement and then requiring you to pay the 25% penalty. Despite what you may think, it’s not uncommon for married couples to miss this distinction as so many financial assets are held jointly.

RMDs and inherited IRAs

If you’ve inherited multiple IRAs, you can aggregate the associated RMDs and withdraw the total from just one of the inherited IRA accounts only if these came from the same decedent. Keep in mind that Roth IRA beneficiaries are generally subject to the same requirements as traditional IRA accounts.

You can donate your RMD to charity and save on taxes

This strategy—also known as the “qualified charitable distribution (QCD) rule”—provides a few opportunities for owners, including the option to transfer up to $100,000 from a traditional IRA account to an IRS-qualified charity on an annual basis rather than pay taxes to the government. (Please note this amount will be indexed for inflation beginning in 2024.) The corresponding benefit? You are allowed to exclude the QCD from your taxable income.

You may be able to delay your RMD by remaining employed

What’s known as the “still-working exception” allows you to delay RMD requirements for your employer-sponsored retirement account, provided you meet the following conditions: you’re still working (perhaps that’s obvious, given the name), own less than 5% of the company you work for, and have an employer-sponsored retirement account from your current employer. To be clear, “still-working” means you are employed in any capacity—regardless of how many hours you work per week.

The primary benefit of a still-working exception is that it allows you to postpone an RMD until April 1st of the year following your separation from service (when you leave the company). Keep in mind this exception only applies to accounts with your current employer (rather than companies you no longer work for) and is a potentially viable strategy if you don’t need immediate access to your RMD funds.

You can reduce—or even eliminate—RMDs by converting assets to a Roth IRA

Another strategy to avoid RMDs is converting some of your RMD-mandated retirement account savings into a Roth IRA (called a Roth IRA conversion), as these don’t include any RMD mandates over the span of your lifetime. The most significant implication associated with this option is that you’ll need to pay taxes on the amount of money you convert, as you’re moving pre-tax money; conversions are therefore expensive.

In sum: required minimum distributions (RMDs)

Navigating RMDs isn’t a very straightforward undertaking, and the consequences of making a mistake are often costly. That’s precisely why we recommend meeting with a CFP® professional to better understand how RMDs can impact your overall retirement plan.

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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.