If there’s one aspect of retirement that seems to be a constantly-moving target, it’s the topic of RMDs – required minimum distributions. The RMD is Uncle Sam’s way of forcing retirees to start pulling dollars out of those tax-deferred retirement accounts like the 401(k) and 403(b) accounts offered by many employers. The amount of money involved here is staggering: one source pegged the total 401(k) balance at roughly $7.3 trillion just two years ago! That represents a lot of tax dollars – so it’s no wonder the issue of withdrawing those pre-tax funds (and collecting all that tax revenue) is on the government’s mind.
But RMD rules do keep changing, which is why we wanted to bring you this recent article from US News on the topic. Reporter Emily Brandon provides a snapshot of the current RMD rules along with some practical how-to tips for making required withdrawals. The important thing to remember is that RMDs need to be taken seriously – some hefty penalties await if you ignore the rules.
The Tax Bill Has Come Due
“After years of delaying income tax on your 401(k) and individual retirement account contributions,” Brandon writes, “you must finally pay the tax bill in retirement.” This bill comes in the form of income tax to be paid on the withdrawals you’re required to make from 401(k), 403(b), and traditional IRA accounts. RMDs are mandated by the IRS after age 73, and each withdrawal triggers an income tax obligation.
Brandon lists seven pointers about how and when to take your RMD withdrawals. There are ways to do this, she writes, “while preserving as much spending power as possible.” Let’s take a look.
Start RMDs After Age 73
The first question you might be asking is “When?” If you’re 73, the answer is now. “You must take your first required minimum distribution by April 1 st of the year after you turn 73,” says Brandon. During each subsequent year, the deadline is December 31 st. Fail to comply and the bite becomes costly. “The penalty for failing to take a required minimum distribution is a 25 percent tax in addition to regular income tax on the amount that should have been withdrawn,” says US News. For wealthy savers with hefty balances, that adds up fast.
(Brandon notes that the penalty could be reduced to 10 percent if you act quickly to correct the oversight. This article from Investopedia gives more information about steps to take if you miss an RMD deadline.)
By the way, the US News article suggests that the age to start required minimum distributions is going to increase to 75 starting in 2033. Based on experience, we predict more adjustments long before then.
Avoid Taking Your RMD Twice in the Same Year
While you will have extra time to take your first RMD – until April 1 st in the year after you turn 73 – delaying might be costly. “Retirees who delay their first required minimum distribution until April 1 will need to take two distributions in the same year,” says Brandon, “because the second distribution will be due December 31.” Both those withdrawals will be taxed as income, which could significantly increase your income tax bill in that first year of RMDs.
“Waiting to take your first RMD until the following year may sound great to defer the income. However, it will increase your income in the tax year that you take both,” says Curtis Bailey, a Cincinnati-based financial planner. “This could not only affect the taxable amount of your Social Security benefits but also increase Medicare surcharges.” ( This Fortune article explains how those income-based Medicare Part B surcharges can surprise retirees.)
Delay 401(k) Withdrawals if You Are Still Working
If you’re still working at age 73 and beyond, can you delay your RMD withdrawals? The answer is yes – but only on the current 401(k) you’re actively contributing to. Any pre-tax IRAs or 401(k)s from previous jobs are subject to RMD rules. You won’t have to consider taking RMDs from your current plan until April 1 st of the year after you retire, the article explains. (Note that different rules apply if you own a 5 percent or greater stake in the company you work for, so you’ll need to consult a good tax planner.)
Brandon spoke with financial planner Emily Benedetto of Santa Monica. Her advice is to look into the rollover option. “If you’re still working and want to avoid RMDs from your IRAs, check to see if your company plan accepts rollovers, Benedetto suggests. “You could roll your IRA assets into the 401(k) and avoid the RMDs during your working years.”
Make Sure the RMD Amount is Correct
“A required minimum distribution amount is generally calculated by dividing your account balance by an IRS estimate of your life expectancy,” says US News. We checked several sources online and found this January article from BankRate.com showing the factors used by the IRS to calculate payments. For example, a 75-year-old would divide their year-end account balance by 25.5 to calculate RMD due. (Note that your spouse’s age might affect your RMD. “If you have a spouse who is more than 10 years younger than you and the sole beneficiary of your IRA, your spouse’s age must also be factored into the calculation,” Brandon writes.)
You can exceed the RMD if you want to. “Retirees can withdraw more than the required minimum amount each year,” says US News, “but excess withdrawals will not count toward required distributions in future years. You can take any number of withdrawals throughout the year, as long as the minimum is met by December 31 (or April 1 for the first distribution).”
Take Distributions from the Worst-Performing Account
People with multiple accounts often ask if they have to withdraw from each one. The answer, says US News, is no – but every account you have needs to be added to the calculation for RMDs. Still rules are different for IRAs and 401(k) accounts.
“If you have several IRAs, you must calculate the required minimum distribution for each account,” Brandon writes, “but you don’t have to take a separate withdrawal from every IRA you own. You can add up your IRA distributions and take it all out of one IRA or a combination of any IRAs you choose.” Financial planner Benedetto told Brandon, “If you had different investments across your accounts, that would be the case where I’d look closer at the holdings and determine the most efficient distribution plan. For example, if you had a particular holding that you didn’t want to sell, you could avoid liquidating it and distribute from a different account.”
What about those 401(k)s you’ve accumulated? “Those with a 401(k) or most other types of workplace retirement accounts must take a withdrawal from each account,” says US News. “However, if you have multiple 403(b) accounts, you can total the required minimum distributions and take them from any account or combination of accounts.” Again, here’s where good advice is essential.
Convert to a Roth IRA
Of course, one way to avoid RMDs entirely is to convert to a Roth IRA, in which dollars grow tax-free. “There are no minimum distribution requirements for Roth IRAs,” says Brandon. “You already paid income taxes on Roth IRA contributions, and the money can be withdrawn as you need it or can be passed on to heirs.”
The problem is that, when you pull money out of a non-Roth 401(k) to convert it to a Roth account, you’ll pay income tax on that withdrawal. “If you know you’ll be in a low tax bracket in the years preceding age 73, you can convert a part of your pretax IRA and pay very little tax on the conversion,” Benedetto says. “That money will then get invested in your Roth IRA and avoid any future RMDs.” (As US News notes, Roth 401(k)s do currently have withdrawal requirements in retirement, but these requirements will be eliminated beginning in 2024.)
Consider Making a Qualified Charitable Distribution
Another way to avoid some of the tax burden of your RMD withdrawals is to be generous. “You can avoid paying income tax on your required minimum distribution if you donate the amount directly from your IRA to a qualifying charity,” says US News.
As North Carolina financial planner Megan Kopka told Brandon, “If you are charitably inclined, starting at age 70 1/2 and after, you can meet your RMD and donate to charity without any impact on your taxes.” Note that this type of qualified charitable distribution can only be made from an IRA, not a 401(k). Also, such gifts are subject to a limit of $100,000 per individual or $200,000 per couple each year. Still, it’s a very nice way to help others while you save on your tax burden!
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(originally reported at https://money.usnews.com)
