Required Minimum Distributions, or RMDs, are the minimum amount you must withdraw each year from most retirement accounts once you hit a certain age. The distributions are taxed as ordinary income, unless they’re from a Roth IRA, which has its own rules. Because RMD rules have changed in recent years–and they were somewhat confusing to begin with–we’ve compiled the information you need to know about RMDs here.
Which accounts have RMDs?
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- Traditional IRAs, SEP IRAs, SIMPLE IRAs
- 401(k), 403(b), and 457(b) plans (for current and former employers, with some exceptions)
- Inherited IRAs & Inherited Roth IRAs – special rules apply based on when the account was inherited. Charles Schwab has this primer on the various rules.
- Important to note, Roth IRAs do not have RMDs during the original owner’s lifetime.
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When do RMDs begin?
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- For most people now: April 1 of the year after you turn 73 (SECURE Act 2.0 bumped this up—age 75 starts in 2033). Basically, if you were born before 1960, your RMD age is 73. If you were born in 1960 or later, your RMD age is 75.
- If you wait until April 1st for your first RMD, you’ll take two that year (one for last year, one for the current year). We generally advise you to take your first RMD in the year you hit your RMD age, rather than doubling up the following year. This latter approach can result in a higher marginal tax bracket, depending on the size of your retirement accounts.
- If you’re still working and your plan allows it, you may be able to delay RMDs from your current employer’s 401(k) until you retire.
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How are RMDs calculated?
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- Your RMD is based on your retirement account balance on December 31st of the previous year. Divide this balance by your IRS Uniform Lifetime Table life expectancy factor.
- For example, if your December 31st balance is $1 million and your life expectancy factor is 23.7, your RMD would be $42,194.
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How are RMDs taxed?
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- RMDs from pre-tax accounts count as ordinary income in the year you take them.
- They can bump you into a higher tax bracket, affect Medicare premiums, and potentially make more of your Social Security taxable, so you’ll want to understand the implications.
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Is there a penalty if you miss an RMD?
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- If you miss taking an RMD, the penalty used to be 50% of the shortfall. Now it’s 25% and can drop to 10% if you fix it quickly. Still, penalties are easy to avoid with proper tracking, something we do for our clients at P&A.
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Strategies to manage Required Minimum Distributions
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- Start withdrawals earlier to spread out the tax hit. If you have a large 401(k) or IRA balance (think north of $1 million), you may want to begin whittling down the balance before RMDs kick in.
- Roth conversions are one such way of reducing eventual RMDs. Often, these work best when you’re in a low tax bracket. For example, after you have retired, but before you begin Social Security retirement benefits. Converting monies from a traditional IRA to a Roth IRA involves recognizing income and paying income tax on these dollars. Accounting for all the potential impacts of a Roth conversion is best done with planning. Unfortunately, you can’t do a Roth conversion from an Inherited IRA.
- Qualified Charitable Distributions (QCDs) – If you are charitably inclined, consider taking advantage of Qualified Charitable Distributions (QCDs). These are donations to charitable organizations made directly from your IRA account. To qualify, you must be 70.5 years or older. You can do a QCD from an Inherited IRA.
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RMDs are all about Uncle Sam calling in those pre-tax dollars to collect the income tax you deferred for many years. With proper planning, there are ways to minimize the tax impact.
We routinely help our clients with Roth conversions, Qualified Charitable Distributions, and creating a retirement paycheck from an IRA. If you’re approaching RMDs or already taking them and want planning help, please connect with us here.
For more information from the IRS about Required Minimum Distributions (RMDs), click the link.
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