If you’ve spent decades building your retirement savings, eventually the IRS requires you to begin taking some of that money out. These mandatory withdrawals are known as Required Minimum Distributions, or RMDs. RMDs may sound straightforward, but they can have a significant impact on your taxable income and overall retirement strategy. Understanding the rules before you reach RMD age can give you more opportunities to plan ahead. Here are 9 important RMD facts every retiree and future retiree should know.
1. What exactly is an RMD?
RMD stands for Required Minimum Distribution. It is the minimum amount the IRS generally requires you to withdraw each year from certain tax-deferred retirement accounts once you reach the applicable age.
You received tax advantages while accumulating money in these accounts. RMD rules are essentially the point when the government begins requiring distributions that generally become taxable income.
2. For many retirees, RMDs begin at age 73
Under current law, many retirement account owners are required to begin RMDs at age 73. Your exact starting age depends on your birth year, which makes it important to know which rules apply to you rather than simply assuming everyone starts at the same age.
3. Born in 1960 or later? Your RMD age is 75
Under current federal law, individuals born in 1960 or later generally have an RMD starting age of 75. That additional time can create an important planning window between retirement and the beginning of RMDs. Depending on your situation, those years may present opportunities for tax planning, Roth conversions, or other retirement-income strategies.
4. Which retirement accounts have RMDs?
RMD rules generally apply to tax-deferred retirement accounts, including: Traditional IRAs, Traditional 401(k)s, SEP IRAs, SIMPLE IRAs.
Other employer-sponsored retirement accounts may also be subject to RMD rules.
5. Roth IRAs are different
One of the major advantages of a Roth IRA is that the original account owner generally does not have lifetime RMDs. That can make Roth assets particularly valuable when planning for taxes, retirement income and wealth that may eventually be passed to beneficiaries. Keep in mind that inherited Roth IRAs have separate distribution rules.
6. How is your RMD calculated?
Your annual RMD is generally calculated using your retirement account balance as of December 31 of the previous year and an IRS life-expectancy factor. As your account value changes, and as you get older, the amount you’re required to withdraw can change as well.
7. What does an RMD look like in real dollars?
Here’s a simple example. Suppose you’re 73 years old and had $500,000 in a Traditional IRA on December 31 of the previous year. Using the IRS Uniform Lifetime Table divisor of 26.5, the calculation would be: $500,000 ÷ 26.5 = approximately $18,868 That means you would generally be required to withdraw about $18,868 for the year. And remember: that’s the minimum. You can generally withdraw more if you need additional retirement income.
8. RMDs can increase your taxable income
RMD withdrawals from pre-tax retirement accounts are generally taxed as ordinary income. This is where retirement planning becomes especially important. A larger RMD can increase your taxable income and potentially affect other parts of your financial picture. That’s why it can be beneficial to start thinking about RMDs years before you’re actually required to take them. Strategies such as Roth conversions and Qualified Charitable Distributions (QCDs) may be worth discussing depending on your circumstances.
9. Missing an RMD can be expensive
Failing to take the required amount can result in an IRS excise tax. Under current rules, the tax can generally be 25% of the amount that should have been withdrawn, although it may be reduced to 10% when the mistake is corrected within the applicable correction window. That makes RMD planning something you don’t want to leave until the last minute.
A Qualified Charitable Distribution (QCD) allows individuals who are age 70½ or older to transfer money directly from an IRA to a qualified charity. One of the biggest advantages is that the amount sent directly to the charity can satisfy all or part of your Required Minimum Distribution (RMD) while generally not being included in your taxable income. This can be especially valuable for retirees who do not need their RMD for living expenses but still want to support a church or favorite charity. To make a QCD, the distribution must be sent directly from your IRA custodian to the eligible charity, rather than having the money paid to you first. Be sure to tell your financial advisor and IRA company that you want the distribution processed as a QCD and keep the charity’s acknowledgment for your records.
RMD Planning Is About More Than Taking a Withdrawal The biggest mistake people can make with RMDs is viewing them as simply another annual transaction. A better question is: How will my RMDs fit into my overall retirement and tax strategy? If you’re approaching retirement or already have significant assets in IRAs, 401(k)s or other tax-deferred accounts, planning several years ahead may give you more options. At Legacy Asset Protection, we help individuals and families look at their retirement assets as a complete picture, including retirement income, taxes, RMDs, legacy planning and strategies designed to help protect what they’ve spent a lifetime building. The goal isn’t simply to take your RMD. It’s to have a plan for what happens before, during and after it.
This material is for educational purposes only and is not intended as individualized tax or legal advice. RMD and tax rules can change. Consult your tax or financial professional regarding your individual circumstances.
