As you prepare for retirement, you may be wondering about the many financial decisions that come with this new stage of life. One crucial aspect of retirement planning is understanding Required Minimum Distributions (RMDs). In this blog, we’ll cover what RMDs are, who needs to take them, and strategies for managing them to ensure you’re on track for a successful retirement.
What is a Required Minimum Distribution (RMD) and How Does it Work?
RMD is a minimum amount that the IRS requires you to withdraw annually from your tax-deferred retirement accounts. The goal is to ensure that you don’t leave your money in these accounts forever and eventually pay taxes on it.
Who is Required to take RMDs?
Individuals who have certain tax-deferred retirement accounts such as Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, and other defined contribution plans are required to take RMDs. It is important to note that Roth IRAs don’t have RMDs since they are funded with after-tax dollars.
Our Required Minimum Distribution flowchart will help you understand whether you need to take your RMD or if you can delay it.
When do RMDs Have to be Taken?
If you were born on or before June 30, 1949, you were required to start taking RMDs at age 70 1/2. But if you were born on or after July 1, 1949, the age limit was extended to 72. Here are some essential dates to keep in mind:
- April 1 of the year following the year you turn 72 is the first RMD deadline for most people.
- For subsequent years, the deadline is December 31.
- If you delay taking your first RMD until April 1 of the following year you turn 72, you’ll need to take two RMDs in that year.
Consequences of Not Taking RMDs
Failing to take RMDs can result in a hefty tax penalty. The IRS charges a penalty of 25% and can be reduced to 10% if the IRA owner makes up the RMD in a timely manner. Additionally, if you inherited a tax-deferred account, you’ll also be subject to RMDs. The RMD rules differ slightly from the original account owner’s rules, so be sure to speak with a financial advisor to ensure you’re meeting the requirements.
How to Calculate RMDs
Calculating your RMD can be a bit complex, but it’s essential to make sure you withdraw the correct amount. The amount you’re required to withdraw is based on the balance in your tax-deferred retirement account and your life expectancy.
The IRS provides three methods for calculating your RMD: the Uniform Lifetime Table, the Joint Life and Last Survivor Table, and the Single Life Expectancy Table. Most individuals use the Uniform Lifetime Table, which is based on the account holder’s age and life expectancy. The Joint Life and Last Survivor Table is used if the account owner’s spouse is the sole beneficiary and is more than ten years younger than the account owner. The Single Life Expectancy Table is used by beneficiaries of an inherited account.
The Uniform Lifetime Table takes into account your age and the account balance you need to withdraw.
For example, if you’re 75 years old with a $500,000 Traditional IRA balance at the end of the previous year, your RMD for that year would be $21,739.13. This amount is calculated by dividing the account balance by the distribution period factor from the Uniform Lifetime Table.
It’s important to note that if you have multiple tax-deferred retirement accounts, you’ll need to calculate the RMD for each account separately.
Strategies for Managing RMDs
Managing RMDs can be overwhelming, especially if you have multiple tax-deferred accounts with varying RMD amounts. Here are some strategies to help you manage your RMDs and maximize your retirement income:
- Consolidate your Accounts: consider consolidating your retirement accounts into one account to simplify your RMD calculations and make it easier to manage your retirement income.
- Plan for Taxes: RMDs are taxable income, so it’s essential to plan for taxes when taking your distributions. Speak with a financial advisor to determine the best tax planning strategies for your situation.
- Consider Donating your RMD: if you don’t need your RMD for living expenses, consider donating it to a charity or non-profit organization. Qualified charitable distributions (QCDs) allow you to donate up to $100,000 from your IRA directly to a qualified charity without incurring taxes on the distribution.
- Re-invest your RMD: if you don’t need your RMD for living expenses, you have enough earned income for the year to cover the contribution, and you don’t exceed the income limits consider reinvesting it in a taxable account or using it to fund a Roth IRA to minimize taxes in the future.
Understanding RMDs is a crucial step in planning for retirement. RMDs ensure that individuals withdraw a minimum amount annually from their tax-deferred retirement accounts and pay taxes on them eventually. Knowing who is required to take RMDs and when they have to be taken is essential to avoid hefty tax penalities. Calculating RMDs can be complex, but using the Uniform Lifetime Table is the most common method. As you approach retirement, be sure to speak with a financial advisor to ensure that you’re on track for a successful retirement and that your RMDs are managed efficiently.
To learn more about RMDs and how to manage them, schedule your free 10-minute guidance call. During this call, our team will be happy to answer any questions you have!