facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause

Planning for your first RMD

Qualified retirement plans like 401(k)s and IRAs offer an incredible tax advantage of a tax deferral on contributions and growth until distribution. However, to prevent individuals from taking advantage of the tax-deferred growth in perpetuity, there are certain rules in place. One of those being the Required Minimum Distribution (RMD) rule.

Taxpayers with qualified retirement accounts are required to start taking distributions from those accounts at the attainment of certain ages. The current required beginning age is 73 as a result of the SECURE 2.0 Act. Prior to 2020 the required beginning age was 70 ½. Then, from 2020-2022 it was age 72. Beginning in 2033 the required beginning age will increase again to age 75.

The basics of RMDs

The RMD rules apply to all employer-sponsored qualified retirement accounts and IRAs, except for Roth IRAs and, beginning in 2024, Roth 401(k)s, another SECURE 2.0 change. If someone is still working at or beyond the required beginning age and their company offers a qualified plan, the distribution requirement is deferred until the person retires or stops working for that company. However, if you own more than 5% of the company when you hit the required beginning age you would be required to begin taking your RMDs at that time.

The annual RMD amount is calculated using life-expectancy table created by the IRS. The intent is to draw down tax-advantaged retirement accounts over the life of the taxpayer. As a result, the minimum distribution amount will change each year depending on the current age factor, the prior year’s distributions and market performance.

Your required minimum distribution must be taken by the end of the year each year after the required beginning age. There is, however, one exception. In the first year an RMD is required to be taken, there is a three-month grace period, and the distribution must be taken by April 1st of the following year to avoid a tax penalty. The second year’s RMD would still be required to be taken that year, so this does result in two distributions in the second year.

How to calculate your RMD amount

As mentioned previously, the RMD is calculated using a life expectancy factor provided by the IRS. The factor is based primarily on age, but also the spouse’s age, if applicable. Most people will use the Uniform Life Expectancy Table, but those with spouses 10 or more years younger who are the sole beneficiaries of the account are subject to the Joint Life and Last Survivor Expectancy Table. This table accounts that the younger spouse may live significantly longer and may rely on the inherited assets.

To calculate the RMD, the balance of the applicable account on the last day of the prior tax year is divided by the life expectancy factor.

For a simple example, say you are 74 years old and the year is 2023. Your IRA account value as of 12/31/22 was $100,000.00 and your life expectancy factor is 25.5. You would simply take $100,000/25.5 and get a required minimum distribution of $3,921.57.

Taking your RMD

Required minimum distributions can be achieved many ways so long as the full amount is distributed within the year. There are no limits on the number of distributions or the amount you can pull throughout the year. You can take the distributions bi-weekly, monthly, quarterly, or as one lump sum distribution. The choice is up to you and your income needs. Remember, distributions from qualified plans are taxed as ordinary income. You should speak with you financial professional and CPA to determine what state and federal tax withholding rate should be used on these distributions.

Prior to 2023, failing to take the RMD could result in a 50% penalty on the amount not taken however, due to the SECURE 2.0 Act, the amount not withdrawn is now penalized at 25% and, if corrected in a timely manner, that penalty is reduced to 10%.

Qualified Charitable Distributions

There is one strategy that can be used to reduce your tax liability when it comes to RMDs which is called a Qualified Charitable Distribution (QCD). A QCD is a direct transfer of funds from your qualified retirement account, payable to a qualified charity. This is an interesting option for charitably minded investors who may not need the full amount of their RMD for living expenses.

Donations must be made directly to 501(c)(3) organizations to be qualified. QCDs cannot be distributed directly to the account owner and then given to a charity. These distributions are not subject to tax withholding, although state rules may vary. The QCD must come out by the RMD deadline, generally December 31st. The maximum annual amount that can qualify for a QCD is $100,000.

Consult with trusted professionals

Given the complexity of the required minimum distribution calculation and process, you should always consult with your financial professional and tax advisor to discuss a strategy for your RMDs as you near the required beginning age.

 

Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.