Required Minimum Distributions, or RMDs, are distributions that must be made from a retirement account once the account holder reaches a certain age.
One of the reasons the RMD exists is to force money that was originally tax-deferred to go through the tax system. This is the government’s way of getting their cut.
RMD rules apply to all employer sponsored retirement plans including: profit sharing plans, 401k plans, 403b plans and 457b plans. The rules also apply to traditional IRAs and IRA-based plans such as SEPs, SARSEPs, and SIMPLE IRAs.
RMD rules do not apply to the Roth IRA but do apply to Roth 401ks.
For purposes of this blog, we’ll focus on RMDs for IRAs.
IRAs Owned By You
There are different rules for IRAs you own vs. an IRA you inherit.
If you are the account owner, you must take your RMD starting in the year you turn 72. You can delay your first RMD until April 1st of the year following the year you turn 72, but you’ll need to take that year’s RMD as well in the same year, so two RMDs in your first year if you decide to delay. All subsequent RMDs must be taken by December 31st each year.
You might see your RMD on your account statement from your custodian, but it’s up to the individual to take out the appropriate amount each year to satisfy their RMD. Missing an RMD could mean facing a 50% penalty on the amount not taken.
How RMDs are Calculated
If your RMD is not calculated on your statement, it’s easy to calculate on your own.
For accounts owned by you, you’ll use the Uniform Lifetime Table. If your spouse is more than 10 years younger and is your sole beneficiary, you’ll the Joint Expectancy Life Table.
From there take your December 31st IRA balance and divide by the divisor associated with your age. The result is the dollar amount you’ll need to take from your IRA before year end.
The nature of RMDs is that they typically increase with each passing year since the divisors get smaller.
SECURE 2.0
Thanks to medical advancements we are living longer than ever, which has caused legislators to continuously reevaluate the RMD age.
Just a few years ago the RMD age was bumped from 70 ½ to 72.
If SECURE 2.0 passes in the Senate, the RMD age will increase to 73, effective January 2023. Then to age 74 starting in 2030 and to 75 in 2033.
While legislators continue to evaluate the RMD age, the IRS has taken a little longer to update the life expectancy tables. That changed in 2022 when they updated the tables for the first time in 20 years.
If you’re already taking RMDs, you may have noticed that your 2022 RMD might have been smaller than it was in 2021. When the life expectancy tables were updated, divisors for calculating RMDs increased making the required distribution smaller.
For example, in 2022 the divisor for someone age 72 is 27.4 while in 2021 the divisor was 25.6. On a $1,000,000 account that’s a difference of about $2,500.
Inherited IRAs
Spouses have more preferential RMD treatment than non-spouse beneficiaries and that really hasn’t changed in the last few years.
The rules for non-spouse beneficiaries, however, did change in 2020 with the passing of the SECURE Act. The new rules limit the ability to stretch the required distribution, forcing those dollars to go through the tax system even sooner.
Non-spouse beneficiaries must now deplete the account by December 31st of the 10th year following the IRA owner’s death. There’s no annual RMD requirement, you just have to take the entire balance within the 10 years.
Exceptions to this rule include payments made to an eligible designated beneficiary. Eligible designated beneficiaries are classified as: a surviving spouse, a minor child of the account owner, a disabled or chronically ill beneficiary, and a beneficiary who is not more than 10 years younger than the original IRA owner.
Minimizing Taxes
We are often asked how to offset the income tax generated by taking an RMD. While there are some strategies you can put in place pre-RMD, short of giving the money to charity, there’s not a whole lot that can be done once you reach RMD age. If you already have charitable intentions, you might consider a Qualified Charitable Distribution (QCD). QCDs are limited to $100,000 per year. As always, we are keeping our eyes on this continuously changing landscape. If you have questions about your RMD, or whether you’re subject to an RMD, please reach out to your TAAG advisor.