RMD Questions: What Are Required Minimum Distributions?

Key Points – RMD Questions: What Are Required Minimum Distributions?

The No. 1 question about RMDs … What Are They?
History of RMDs
Planning for RMDs Before and After Retirement
Strategies for How to Reduce RMDs
Questions About RMDs for Inherited IRAs
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Questions About RMDs

Financial planning can oftentimes seem like alphabet soup. There are acronyms for just about everything. While they’re certainly not fun to talk about, one acronym that we hope you’ve heard of is RMD. That stands for Required Minimum Distribution.

We get a lot of questions about RMDs, including a very straightforward one—what are RMDs? In fact, the IRS has a frequently-asked-questions page about RMDs. What are RMDs is the No. 1 question on the list. So, we figured that we would run through some of the most frequently-asked-questions we receive about RMDs and answer them.

What Are RMDs and Why Do I Need to Take Them?
When Do I Need to Start Taking Them?
Can I Delay an RMD Until After My RMD Age and Then Take Two the Next Year?
How Are RMDs Calculated?
What Happens If I Miss an RMD?
What Are the Penalties for a Missed RMD?
Can an RMD Penalty Be Waived?
How Are RMDs Taxed?
Can I Reduce My RMDs?

History of RMDs

As we begin to dive into some questions about RMDs, did you know that RMDs have been around for nearly five decades? RMDs were introduced when IRA were created in September 1974 with the Employee Retirement Income Security Act (ERISA). Yep, another acronym!

Question No. 1 About RMDs: What Are RMDs … and Why Do I Need to Take Them?

RMDs are the minimum amount that you must take out of your retirement account or IRA each year. They exist so that people can’t amass retirement accounts, put off taxes, and simply pass on their retirement funds to their loved ones as an inheritance. RMDs must be taken from traditional IRAs, SIMPLE IRAs, SEP IRAs, and retirement plan accounts whether you’re retired or still working. That might sound simple, but the rules for RMDs have changed constantly over the past 49 years. Hence why there are so many questions about RMDs.

The SECURE Act and SECURE 2.0’s Impact on RMDs

There have been even more questions about RMDs over the past five years due to the SECURE Act and the SECURE Act 2.0. Prior to the SECURE Act, retirement account owners had to begin taking RMDs in the year that they turned 70½. The deadline for their first RMD was April 1 of the following year that they turned 70½.

When Do I Need to Start Taking RMDs?

Once the SECURE Act became law in 2020, RMD age moved up to 72. The RMD age just moved up again to 73 when SECURE 2.0 became law on January 1, 2023. However, it’s set to move up to 75 by 2033. So, just with the many changes with the required beginning date for RMDs, you can easily see why we get so many questions about RMDs. It hasn’t been easy to keep up with what rules you’re supposed to be following.

How Are RMDs Calculated?

Your IRA custodian or retirement plan administrator might end up doing this for you. Still, you’re responsible for taking the right RMD amount each year. Let’s make sure that you understand how to go about doing that in case you have questions about how to calculate your RMDs.

When you’re calculating an RMD, make sure to have IRS Publication 590-B handy. It includes life expectancy tables that you’ll need when calculating your RMD, and you’ll need to pick the one that fits your unique situation. There are three different tables—uniform lifetime, single life expectancy, and joint and last survivor. Once you determine your life expectancy factor from your table, you’ll divide your account balance (as of December 31 from the previous year) by your life expectancy factor. If you have any questions about properly calculating an RMD, make sure to consult a tax professional.

What Happens If I Miss an RMD and What Are the Penalties?

If you miss an RMD or don’t meet the deadline to take the full RMD amount, the remaining amount is subject to a 50% excise tax. That’s substantial, which is why we can’t stress enough to seek professional help if you have questions about RMDs.

Can an RMD Penalty Be Waived?

That 50% excise tax can open some eyes about why it’s critical to understand how to plan for RMDs. SECURE 2.0 did offer some reprieve on that penalty if you correct a missed RMD. The excise tax falls to 25% if you correct it and to 10% if it’s made up within two years.

The penalty can also be completely waived if you demonstrate that you mistakenly missed taking the RMD in full and are taking the proper steps to correct it. If you missed an RMD and need to correct it, you’ll need to file Form 5329 along with a letter of explanation for why the RMD was missed.

There are some mixed considerations with the new penalty amounts. In the past, we often saw the IRS completely waive the 50% penalty. With the new reduced penalty amounts, many believe the IRS will begin to enforce these penalties more often, which creates a greater emphasis on making sure RMDs are appropriately distributed moving forward.

How Are RMDs Taxed?

You’ll be taxed on the RMD amount at your income tax rate when you take an RMD. They are added to income and be taxed accordingly to the marginal tax bracket you land in. When we’re meeting with people, we make sure that they understand that RMDs can move you or your beneficiaries up into higher tax brackets.

Three Common Questions About RMDs with Point-Blank Answers

Can you take out more than the RMD amount? Yes.
If you have a bigger distribution one year, can you apply some of it to a future RMD? No.
Is it possible to roll over RMD amounts into a different tax-deferred account? No.

Can I Reduce My RMDs?

RMDs can be a very rude awakening in retirement if you haven’t been planning for them. You need to think about RMDs before and after you retire. We hope that you better understand the importance of that after reading through the answers to the questions about RMDs that we’ve answered so far. But there’s one big question about RMDs that we haven’t asked that you’ll want to know the answer to. Can you reduce your RMDs?

If you’ve been listening to America’s Wealth Management Show recently, you’ll know the answer is yes. Let’s review the five strategies that Dean Barber and Bud Kasper shared for how to reduce RMDs.

1. Roth Conversions

While RMDs must be taken for traditional IRAs, there are no RMDs for Roth IRAs. By paying the tax on a Roth conversion, you’ll no longer be subject to RMDs. However, it’s a different story for inherited Roth IRAs. Roth IRA beneficiaries will still need to take RMDs, but fortunately those distributions will likely be tax-free.

But remember, there are pros and cons to doing Roth conversions. No RMDs for Roth IRAs is obviously a pro. There can be unintended consequences to Roth conversions, though, such as being thrown into a higher Medicare bracket.

So, we have a question about RMDs for you. If you’re going to do a Roth conversion to reduce your RMDs, how will that impact your overall tax strategy? This is why it’s critical to have a CFP® Professional that crafts your plan around your goals and then has a CPA review it from a tax perspective.

As you’re thinking about your tax strategy, remember that the goal is to pay as little tax as possible over your lifetime, not just in one year. Take some time to review our Tax Reduction Strategies guide to get a better understanding of Roth conversions and other tax planning strategies.

Download: Tax Reduction Strategies Guide

2. Qualified Charitable Distributions

Before you think about doing Roth conversion after Roth conversion to reduce your RMDs, hold on for a second. We have another question about RMDs for you. Are you charitably inclined? If you said yes and you’re 70½ or older, you can reduce RMDs through Qualified Charitable Distributions. Through QCDs, you can take money out of your traditional IRA and give it directly to charity without needing to report it on your tax return.

As you’re deciding between Roth and traditional, keep QCDs in mind. You can transfer a maximum of $100,000 a year to charity from your IRA tax-free and they satisfy your RMDs. So, there’re a case to be made for having some money in traditional.

3. Strategically Managing Your IRAs

Did you know that 59½ to 73 is the ideal age range to do IRA planning? We’ve already addressed age 73 with it being the RMD age for 2023. But why is 59½ at the beginning of that age range? It’s because if you’re under 59½ and take an early withdrawal from your IRA, you’re subject to a 10% penalty. Now, there are 20 exceptions to that 10% penalty. Make sure you’re aware of those exceptions.

After you turn 59½, you can take distributions penalty-free. That’s important to remember so that you can do some strategic planning for RMDs prior to your required beginning date. Think about what tax bracket you’re in now compared to what tax bracket you could be in the future, especially as you’re approaching RMD age.

4. Delaying When You Take Social Security

Sixty-two is another important age to keep in mind during the retirement planning process. That’s when you become eligible to start claiming Social Security. While it can certainly be appealing to start claiming it ASAP, you need to play the long game here. The longer you wait to claim Social Security, the larger the benefit you’ll get.

By delaying when you claim, you can take money out of your accounts in a manner that you can reduce your taxes over time. The amount of your Social Security benefit plays a factor in what your RMDs will be. The more you have in Social Security income at the beginning of retirement, the less amount you can convert to Roth and remain in a lower tax bracket. Again, tax bracket management is a big deal.

5. Qualified Longevity Annuity Contracts (QLACs)

Funds that you invest in a QLAC aren’t included in your balance when calculating RMDs until age 85. That’s clearly a factor when it comes to longevity risk. QLACs became easier to buy following some SECURE 2.0 provisions. You’re able to defer more taxes and buy more retirement income from your 401(k)/IRA.

Before SECURE 2.0, you could purchase with the lesser of $125,000 or 25% of your retirement funds. The 25% limit is applied separately to each employer plan, but in aggregate to IRAs. Currently, the maximum QLAC is $200,000 per person with a savings limit of 0%.

A Not-So-Great-But-Obvious Bonus Option: Keep Working

This is an obvious way to reduce RMDs, but you can always continue working. If you truly enjoy your job, that’s definitely something to consider. But if you’re ready to retire, it’s critical to have a plan for how to reduce your RMDs. Hopefully, you can see why it’s so important to plan for RMDs before and after retirement.

Questions About RMDs with Inherited IRAs

RMD rules can be difficult to follow for your own retirement accounts. They can become even more complex with inherited IRAs. We receive plenty of questions about RMDs for inherited IRAs as well. Let’s circle back to the SECURE Act really quick.

The SECURE Act went into effect on January 1, 2020. Since then, assets within the accounts of IRA owners who passed away after December 31, 2019, have needed to be distributed over the span of 10 years. The 10-year rule applies regardless of if the original account owner already reached their required beginning date for RMDs. There are only four beneficiary demographics who are exempt from this 10-year rule.

Surviving spouses.
Children under 18.
Someone who is disabled or chronically ill.
Someone who isn’t more than 10 years younger than the account owner.

To sum it up, traditional IRAs aren’t a very effective wealth transfer vehicle anymore. And think about this. There are a lot of people who inherit traditional IRAs during their peak earning years. That additional income could throw them into a higher tax bracket. Once again, this is why planning for RMDs before and after retirement is critical so that you’re mitigating taxes over your lifetime.

Do You Have Other Questions About RMDs?

We covered quite a bit of ground with these questions about RMDs. And we’re well aware that all this info can lead to even more questions about RMDs. So, if you have any questions, we encourage you to reach out to us.

There’s no shame whatsoever in seeking professional help with something as complicated as RMDs. One of CFP® Professionals and/or CPAs can walk through your questions about RMDs during a 20-minute “ask anything” session or complimentary consultation. We can meet with you in person, virtually, or by phone—whatever works best for you.

Resources Mentioned in the Episode

Downloads

Tax Reduction Strategies

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.