Required Minimum Distributions or “RMD’s” are the minimum amount that must be withdrawn from pre-tax, tax-deferred retirement accounts, such as IRA’s, 401k’s, qualified variable annuities, or Pension plan accounts, generally beginning at age 73. There may also be RMD’s on inherited IRA’s before the age of 73. For most retirees the RMD rules are not burdensome, but the penalties for non-compliance are steep, so it is important to understand the rules and work with an advisor to make sure you make your distributions each year. Here is a quick overview of the key rules you should know.
1. When do RMD’s Start?
Secure Act 2.0 recently changed the required beginning date for RMD’s to age 73 for individuals attaining age 72 after December 31, 2022, and pushed the RMD age to 75 effective December 31, 2032. (You may have heard that RMD’s begin at age 70.5, but that is the old rule and has been superseded). Technically, the first RMD is due by April 1st of the year after you turn age 73 and is due annually by December 31st thereafter. However, most retirees will want to begin their RMD’s in the year they turn 73.
2. How much is your RMD?
The RMD is calculated using the balance in your pre-tax retirement accounts as of December 31st of last year divided by your life expectancy. At age 73, life expectancy (per the IRS) is 26.5 years, so the first year RMD is about 3.8%, which is a relatively modest amount for most retirees, and nothing to worry about. However, as you age, your life expectancy decreases and RMD’s can become significant. For example, life expectancy at age 80 is 20.2 years, which means that the RMD is about 5% of the account value, and at age 90 life expectancy is 12.2 years, which means that the RMD is about 8.2% of the account. (Life expectancy is an odd calculation. According to the actuaries, the longer you live the longer you are expected to live, so your life expectancy does not decline by a year for every year you age, and your life expectancy never reaches zero, which is a good thing. Don’t ask me why, I’m not an actuary!)
3. What if I distribute more than the RMD?
If you are already distributing more than the RMD, nothing changes. In fact, many retirees find that RMD’s are initially a non-event. For example, if you are a retiree living off your retirement savings, and distributing 4% of your account value each year, you do not have to change anything. You can simply continue distributing the 4% and you will exceed the required minimum distribution of 3.8%. However, remember that the RMD will increase each year, so future years may still require you to increase your distribution.
4. What if I have multiple retirement accounts?
If you have multiple accounts you must calculate the RMD for each tax-deferred account. IRA accounts may be combined, allowing you to fulfill the combined IRA RMD’s from a single account. However, RMD’s for employer-sponsored plans must be taken separately. For example, if you have two IRA’s with balances of $500,000 and $700,000, and the RMD’s for the two accounts are $20,000 and $28,000 respectively, then you may take the combined RMD of $48,000 from either account to fulfill the RMD. However, if you also have a $200,000 401k plan with your former employer, with an RMD of $16,000, then RMD for the 401k plan must be distributed from the 401k plan.
5. What if I am still working?
You must take RMD’s from your IRA’s even if you are still working past age 73. However, if you are participating in an employer plan (such as a 401k or 403b), and you are less than a 5% owner in the business, you may delay taking RMD’s from the employer plan until you retire.
6. What if I don’t need the money?
If you do not need the money one excellent way to fulfill your RMD is by giving the money directly to charity as a Qualified Charitable Donation (“QCD”). A QCD counts toward your Required Minimum Distribution but is excluded from your taxable income, which can have superior tax benefits when compared to taking the distribution yourself and then giving money to the charity. If you would like to learn more about QCD's, please see our article "What is a Qualified Charitable Donation?" Another alternative if you do not need the money is to simply transfer the RMD to a taxable account and keep the funds invested. Remember, you are required to pay taxes on the RMD, but that does not mean you have to spend it.
7. Does my Roth Conversion fulfill my RMD?
In short, no, Roth Conversions do not count toward the RMD. However, Roth Conversions may still help reduce your RMD in the long term. Roth IRA’s do not have RMD’s during the owner’s life. Therefore, converting some of your pre-tax IRA’s can reduce the overall balance subject to RMD’s. In fact, annual Roth conversions can be a smart way to plan for RMD’s before they start. If you want to learn more about roth conversions, please see "Strategic Roth Conversions: Maximizing Retirement Savings While Minimizing Taxes."
8. What if I still have questions?
If you still have questions, please feel free to give us a call. We would be happy to help.