Understanding Required Minimum Distributions - RMDs
As you approach retirement, it’s important to understand the rules and regulations surrounding your retirement accounts. One of the most important aspects to be aware of is Required Minimum Distributions (RMDs). In this article, we’ll dive into what RMDs are, how they work, and what you need to know to ensure you’re following the rules. This article only applies to RMD rules for original retirement account owners. Retirement accounts that are inherited from someone else have a different set of rules that apply.
What Are Required Minimum Distributions (RMDs)?
Required Minimum Distributions (RMDs) are the minimum amount of money that must be withdrawn from certain retirement accounts each year once you reach a certain age. These accounts include traditional IRAs, SEP IRAs, SIMPLE IRAs, and 401(k)s.
RMDs make sure people can't avoid paying taxes on their retirement savings forever. The money in these accounts has been growing tax-deferred, meaning you haven’t paid taxes on it yet. RMDs ensure that the government receives their share of taxes on this money once you start withdrawing it.
What Are the RMD Rules?
The Required Beginning Date (RBD) is the deadline for starting to withdraw money from your retirement accounts, known as RMDs. The Required Beginning Date (RBD) is April 1st of the year after you turn 73. If you wait until the next year, you will have to take two distributions. One distribution is for the previous year, and the other is for the current year. This can make sense in certain situations, but for most people taking their first RMD in the year they turn 73 makes the most sense. After the first year, RMDs are due by December 31st of each year going forward.
The RBD rules can be complex. Consulting with a financial advisor or tax professional can help you understand the requirements for your situation.
The amount you are required to withdraw is based on your life expectancy and the balance of your retirement accounts. The IRS provides a table, known as the Uniform Lifetime Table, to determine the amount of your RMD. This table takes into account your age and the balance of your retirement accounts to calculate the amount you must withdraw each year.
Are Annuities Subject to Required Minimum Distributions?
Annuities are a type of retirement account that is subject to RMDs. However, there are some exceptions. If you have a qualified longevity annuity contract (QLAC), you are not required to take RMDs until the age of 85. This allows you to defer taxes on this money for a longer period of time.
Additionally, if you have a non-qualified annuity, meaning it was purchased with after-tax dollars, you are not required to take RMDs. However, if you have a qualified annuity you are subject to RMDs.
What Are the Tax Implications of RMDs?
RMDs are subject to income tax, meaning the amount you withdraw will be added to your taxable income for the year. This can potentially push you into a higher tax bracket, resulting in a higher tax bill.
It’s important to plan for RMDs and consider the tax implications when determining your retirement income strategy. Consulting with a financial advisor (like us) can help you create a plan that minimizes the tax impact of RMDs.
What Happens If I Don’t Take My RMD?
If you fail to take your RMD, you will be subject to a penalty of 25% of the amount you were supposed to withdraw. For example, if your RMD was $10,000 and you failed to take it, you would be subject to a penalty of $2,500. This penalty is in addition to the income tax you will owe on the RMD amount.
It’s important to stay on top of your RMDs and ensure you are taking the correct amount each year to avoid this penalty.
How Can I Calculate My RMD?
Calculating your RMD can be a bit complicated, as it involves taking into account your age, the balance of your retirement accounts, and the IRS’s Uniform Lifetime Table. However, there are many online calculators available that can help you determine your RMD amount.
One option is the RMD calculator provided by Charles Schwab on their website. This calculator allows you to input your age, the balance of your retirement accounts, and the type of account to determine your RMD amount.
What Are Some Strategies for Managing RMDs?
There are a few strategies you can use to manage your RMDs and minimize their impact on your taxes.
Roth Conversions - One strategy is to convert some of your traditional retirement accounts to a Roth IRA. This involves paying taxes on the amount you convert, but it can help reduce the amount of your RMDs in the future. Roth IRAs are not subject to RMDs, so by converting some of your traditional retirement accounts, you can reduce the amount of taxable income you will have in retirement.
Qualified Charitable Distributions (QCDs) - Another strategy is to make Qualified Charitable Distributions (QCDs). This involves donating your RMD amount directly to a qualified charity. By doing this, the amount of your RMD is not added to your taxable income, reducing your tax bill for the year.
Planning Ahead - The best strategy for managing RMDs is to plan ahead. By working with a financial advisor (like us), you can create a retirement income plan that takes into account your RMDs and minimizes their impact on your taxes. This may involve a combination of strategies, such as Roth conversions and QCDs, to create a tax-efficient retirement income plan.
Conclusion
Understanding RMDs is an important aspect of planning for retirement. By knowing the rules and regulations surrounding RMDs, you can ensure that you are following the guidelines and avoiding penalties.
RMDs is a great subject to bring up with a financial advisor. If you don’t have one but want to work with one then feel free to reach out to us to schedule a complimentary appointment, or you can do a search for financial advisor near me to find one who can help. Please remember that nothing referenced in this paper should be construed as tax or legal advice.