If you have any tax-deferred retirement accounts, the IRS mandates that you begin taking RMDs the year you turn 73. These include profit-sharing plans; traditional individual retirement accounts (IRAs); rollover IRAs; SIMPLE IRAs; SARSEPs; SEP IRAs; inherited Roth IRAs; most small-business accounts (Keoghs); and most 401(k), 403(b) and 457(b) accounts.
The RMD rules do not apply to Roth IRAs or Designated Roth accounts while the account owner is alive. However, RMD rules do apply to the beneficiaries of Roth IRA and Designated Roth accounts.
Because these accounts are funded with pre-tax dollars, they enable tax-deferred growth. The IRS mandates RMDs so it can collect income tax on those funds. In late 2022, the SECURE 2.0 Act established age 73 as the age at which people are required to start taking their RMDs; previously, they had to begin at age 72. This age limit will increase to 75 by 2033.
1. Start planning to make your RMD before you turn 73
You must take the distribution by December 31 of the year you turn 73. However, there is a grace period — you can delay your first RMD for the year you turn 73 until April 1 of the following year. If you do that, you will also need to take your second RMD for that same year by December 31. Receiving two payments in one year could push you into a higher tax bracket, so it’s a good idea to consult with your advisor before delaying your first payment. The grace period is available only for your first RMD.
2. Consolidate all your accounts in one place
Many times, retirees have several such accounts, and often, they have accounts in several different locations. When we begin working with new clients, we encourage them to move all their accounts to our office. Not only is it easier to manage your finances when all your accounts are in one place; it also can save you money on fees. Also, consolidating all your financial accounts in one place prevents potential over- or under-diversification.
3. Contact your retirement account custodian
Once all your accounts are consolidated with one advisory firm, contact your retirement account custodian and specify how you want to receive the funds. You can receive the money via electronic deposits to your bank account, have a check mailed to you or withdraw the money and put it toward after-tax accounts, including brokerage accounts, mutual fund accounts, after-tax annuities and college savings funds.
It’s important to know that although your account custodian will provide information and help you with logistics, you are personally responsible for ensuring that the correct amount is taken for your RMD.
If you fail to take the full amount of your RMD, there is a penalty. However, the SECURE 2.0 Act reduced the penalty from 50 percent to 25 percent. If you correct the error within two years, you could pay just a 10 percent penalty.
4. Complete IRS Form 1099-R
The custodian will ask you to complete IRS Form 1099-R to report the distribution and any withheld taxes. He or she will give you a copy, which you need to give to your tax preparer. You can request a specific amount or percentage of your RMD to be withheld for federal and state taxes. Typically, the default is 10 percent.
The IRS taxes RMDs as ordinary income. This means your withdrawals are included in your total taxable income for the year, which could push you into a higher tax bracket. That will affect the amount of taxes you pay for your Social Security or Medicare.
Your RMD amount is calculated by dividing your tax-deferred retirement account balance as of December 31 of the previous year by your life-expectancy factor — unless your assets are held within an annuity.
If you own more than one IRA, you must calculate your RMD separately for each account. However, you can withdraw the total of all your RMDs from a single account or any combination of IRA accounts you own. You cannot combine RMD obligations or withdrawals to meet obligations with spousal accounts.
Your life expectancy factor is taken from the IRS Uniform Lifetime Table or the IRS Joint Life Expectancy Table, depending on your age and the age of your account’s beneficiary.
5. Look into a delay if you are still working
If you are still working, you may qualify for an exception from taking RMDs from your current employer-sponsored retirement account, such as a 401(k) or 403(b). If you meet all the requirements, you can delay taking an RMD from the account until April 1 of the year after you retire.
If you contribute to a workplace retirement plan such as a 401(k) or profit-sharing plan, you can delay taking your RMDs until the year you retire, unless you are a 5 percent owner of the business that sponsors the plan. You can withdraw more than the minimum required amount. Your withdrawals are included in taxable income — except for any part that was already taxed (your basis) or that you can receive tax-free (such as qualified distributions from designated Roth accounts).
6. Consult with an experienced advisory team
It is important to talk to a financial advisor and/or tax advisor before you take your first RMD.
If you are nearing age 73, I encourage you to reach out to us so we can walk you through options you have, based on your personal situation. We’ve seen people make just about every RMD mistake there is, and they can be frustrating and costly. These mistakes include missing deadlines, miscalculating the RMD amount by using the wrong balance or an incorrect life-expectancy table and failing to consider Qualified Charitable Distributions (QCDs), which could save money on taxes.
We realize RMDs can be confusing, but we love this stuff! Please contact us so we can make it all easier to understand — and help you prevent common mistakes.
