What Are RMDs?
If you have a tax-deferred retirement account, such as a traditional IRA or 401(k), understanding Required Minimum Distributions (RMDs) is essential for proper financial planning. The IRS mandates these withdrawals to ensure that individuals do not indefinitely defer taxes on their retirement savings. Here’s what you need to know about RMDs and how they affect your financial future.
What Are Required Minimum Distributions (RMDs)?
RMDs are the minimum amount you must withdraw from your retirement accounts each year once you reach a certain age. These distributions are required because retirement accounts like traditional IRAs and 401(k)s were funded with pre-tax contributions, meaning taxes were deferred until withdrawal.
When Do RMDs Begin?
For individuals born before July 1, 1949, RMDs began at age 70½. However, the SECURE Act, passed in 2019, changed the age requirement. If you were born on or after July 1, 1949, you must start taking RMDs at age 72. Additionally, under the SECURE 2.0 Act of 2022, the RMD age increased to 73, beginning in 2023.
The first RMD must be taken by April 1 of the year following the year you reach the required age. Subsequent RMDs must be taken by December 31 each year. So, you will need to take two distributions in the first year if you wait until April 1st of the year following the year you reach the required age.
Which Accounts Are Subject to RMDs?
RMDs apply to the following types of retirement accounts:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) and 403(b) plans (excluding Roth 401(k)s for those turning 73 in 2024 or later)
- Other tax-deferred retirement accounts
Notably, Roth IRAs are not subject to RMDs during the account owner’s lifetime, allowing for greater tax-free growth.
How Are RMDs Calculated?
The IRS provides a formula to determine your RMD each year. It is based on your account balance as of December 31 of the prior year and a factor from the IRS Uniform Lifetime Table. The formula is:
RMD = Account Balance ÷ IRS Life Expectancy Factor
For example, if you have $500,000 in your IRA and your IRS factor is 25.6, your RMD would be $19,531 for the year.
If your spouse is more than 10 years younger than you are, there is an alternative table that may be used for calculating your RMDs. Before acting on any tax related actions, be sure to consult a tax professional.
What Happens If You Don’t Take an RMD?
Failing to take your RMD can result in a significant penalty. Before 2023, the penalty was 50% of the amount that should have been withdrawn. Under the SECURE 2.0 Act, the penalty has been reduced to 25% and can be further reduced to 10% if corrected in a timely manner.
Can You Reduce or Delay RMDs?
While RMDs are mandatory, there are strategies to minimize their impact:
- Convert to a Roth IRA: Since Roth IRAs do not have RMDs, converting part of your traditional IRA to a Roth IRA can help reduce future RMD obligations.
- Delay with Employer 401(k): If you are still working and have a 401(k) with your current employer, you may be able to delay RMDs from that account until you retire.
- Qualified Charitable Distributions (QCDs): If you are 70½ or older, you can donate up to $100,000 per year directly to a qualified charity from your IRA, which satisfies your RMD without increasing taxable income.
Plan Ahead for RMDs
Understanding and planning for RMDs can help you manage your tax burden and ensure your retirement savings last. Consider working with a financial professional to develop a strategy that aligns with your financial goals.
At Hazard & Siegel, we are committed to helping you make informed investment decisions. Contact us today to discuss how we can help you navigate your RMD obligations and optimize your retirement strategy.
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