Required Minimum Distributions (RMDs) are a facet of retirement planning that affect those with retirement accounts and are often misunderstood. First, let’s take a look at what they are, and when they come into play during retirement.
What are Required Minimum Distributions?
RMDs come into play in tax-deferred (pre-tax) accounts, where funds put into the plan resulted in a tax deduction at the time of contribution. These tax-deferred are then be taxed at the time of distribution. For a more in-depth discussion of pre- versus post- tax accounts, see our article on Retirement Withdrawals.
Because the funds put into these accounts have not been taxed, they are required to be pulled out in the future to be taxed. The government’s intention by allowing the tax deduction is to provide tax benefits for the saver during their lifetime; they are not intending for these accounts to allow for tax-deferred, generational wealth creation. Since Roth accounts, on the other hand, are funded with post-tax dollars and are not taxable at the time of distribution, no RMDs are required on Roth accounts during the owner’s lifetime.
After the owner’s passing, RMDs are required for both pre-tax and Roth accounts, assuming these are not rolled into a spousal account. These RMDs must be taken by the beneficiary and are subject to specific schedules depending on age and relationship of the original owner and beneficiary.
When are RMDs required?
The retirement landscape has undergone some significant changes the past few years with the SECURE 1.0 and 2.0 Acts in Congress, and RMD rules have not been an exception. The age at which RMDs begin was increased from 72 to 73 in 2023 and will increase again to 75 in 2033. To summarize:
- Year of Birth between 1951-1959: RMDs begin at age 73.
- Year of Birth 1960 or after: RMDs begin at age 75.
RMDs are required to be taken by December 31st of each year, however the first year you’re allowed to take your RMD by the following April 1st. Keep in mind, delaying into the following year results in two RMDs required in the same tax year, so this may not be advisable. Failure to take your RMD by the required date (typically December 31st) results in penalties. These rules were also changed with the passage of SECURE 2.0 and are more beneficial to those who might have missed an RMD in any given year. If you fail to take out an RMD, a 25% tax (down from 50% pre-SECURE Act) is levied against the amount not taken; however, if the mistake is corrected within two tax years following the year the distribution should have been made, the penalty is reduced to 10%. For example, if an RMD was required to be made in 2023 and missed in that year, the individual has until 2025 to rectify the situation, and pay the 10% penalty instead of the more severe 25% penalty. While not as draconian as pre-SECURE Act rules, this is still a penalty to be avoided and is the main reason we prioritize clients’ RMDs as the end of year approaches.
How Much Will My RMD Be?
RMDs are calculated on an individual basis in each account that RMDs apply. The calculation is based on a “Life Expectancy Table” provided by the IRS and has different variations for different account ownership situations. Fortunately, many retirement providers offer an automated calculator that greatly simplifies the calculation, and only requires inputting some basic information. The calculations used by the IRS are designed to pull money out at an increasing rate as you age.
Having multiple retirement accounts grants flexibility when taking RMDs. Though calculated from each separate account, there is no requirement that RMDs must also be taken from corresponding account. They can be taken out of one or any combination of accounts, as long as the total amount required is satisfied. Proper management of RMDs could result in better long-run performance across various portfolio strategies.
The world of RMDs can be confusing, and the changes brought by SECURE 2.0 have not simplified the process. We are constantly apprised of legislative changes to provide the most benefits to our clients and are always here to answer any questions that might come up.
Qualified Charitable Distributions
Qualified Charitable Distributions (QCDs) are another powerful tool that can allow individuals to give to charities which have a special meaning to them, while doing so in a tax-advantaged manner.
QCDs are distributions directly from a retirement account to a 501(c)(3) charitable organization, without the account owner receiving any of the funds. The key is that since the transfers are made straight to the charity from the retirement account, they are non-taxable distributions. QCDs do not become a possibility until age 70 ½, and each individual can make up to $100,000 of these contributions each year that are excluded from gross income for tax purposes- a couple would be eligible to make $200,000 total in QCDs if both are over 70 ½ and have sufficient IRAs.
QCDs gain another layer of benefit once RMD age is reached- they can be used to satisfy RMD requirements for the year. For example, you have a total RMD requirement of $10,000 for the year but will only need $5,000 from accounts in order to supplement Social Security income. Instead of having to take the entire $10,000, pay taxes, and then leave the extra $5,000 sitting in cash within a bank account, you could withdraw the $5,000 excess as a QCD and avoid taxes on that portion. By using this strategy, you can donate to an organization which you support, while also avoiding taxes on an amount that you were required to withdraw.
For those with higher incomes in retirement, QCDs can be utilized to avoid ending up in higher tax brackets, and especially to avoid increased Medicare premiums. They also can be more tax-advantaged than cash contributions (and the associated itemized deduction), as QCDs reduce Adjusted Gross Income (AGI) on the tax return, which is used for determining the taxable portion of Social Security and other tax credits.
The advantages of QCDs are varied and become readily apparent when viewed within a holistic financial plan, as they provide great flexibility for those with RMD requirements who also want to contribute to charities in a tax-efficient manner.
When making QCDs you’ll receive a 1099-R (tax form reporting the retirement distribution), and it’s important to note to your tax preparer that a portion (or all) of this was a QCD.
Sources: IRS.Gov
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