Take the Surprise out of RMDs

Loren Merkle, CFP®, RICP®, Certified Financial Fiduciary

You’ve spent decades saving for retirement, likely taking advantage of tax-deferred accounts like 401(k)s or traditional Individual Retirement Accounts (IRAs). These are great ways to save, but knowing the rules that come along with these retirement accounts is essential in retirement.

Eventually, the IRS will collect on your tax-deferred accounts. They do this by imposing Required Minimum Distributions (RMDs). You can take the surprise factor out of these distributions by understanding how they work and having a plan for them in retirement.  

RMD 101  
RMDs generally apply to the original owner of a traditional IRA, SIMPLE IRA, SEP IRA, or a retirement plan such as a traditional 401(k) or a Roth 401(k), or a 403(b). Roth IRAs do not have RMDs. RMDs kick in at age 72. The 2019 SECURE Act moved the RMD age from 70 ½ to 72. Legislation passed earlier in 2022 by the House of Representatives would gradually raise the RMD age to 75. The bill is expected to pass before the end of the year.  

You can calculate your RMD by dividing your year-end account balance from the previous year by the IRS life-expectancy factor (click here to see the 2022 table).  

For example, if you turn 72 this year and your IRA account balance was $250,000 on December 31st last year, your life expectancy factor is 27.4. Your RMD is $250,000 divided by 27.4 or $9,124. That is the minimum amount that the IRS requires you to take from the account. Remember that RMD calculations work differently if your spouse is the only primary beneficiary of your account and is more than ten years younger than you.

If you don’t make the proper RMD by the appropriate deadline, the IRS will tax you 50% of the difference between the amount you withdrew that year and the amount you were supposed to take. If you were supposed to withdraw $20,000 but only took out $10,000, the penalty could be $5,000.  

If you have multiple IRAs you can take RMDs from all or just one. If you have 401(k)s or employer plans you must take the RMD attributed to that plan from that specific plan.

Some people use the RMD as income in retirement. The mandated distribution helps them meet their monthly or yearly needs, and the taxes owed are not a primary concern.  

However, many people find that the RMD is a tax problem. The amount may be more than they need, or perhaps they don’t need it at all. If they have a sizable IRA, the RMD could push them into a higher tax bracket in retirement. It could also mean that a larger portion of their Social Security income could be subject to taxes, and they could end up paying more for Medicare Part B or Part D.

For these people, having more control over their RMD could mean paying less taxes in retirement. There are several RMD strategies we consider when helping individuals and families put together a customized retirement plan. They can include consolidating accounts, taking voluntary withdrawals from the account before RMD age, Roth Conversions, or making a Qualified Charitable Distribution (QCD).  

Planning for RMDs allows you to pay taxes on your terms. No surprises.

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