Required Minimum Distributions (RMDs) are minimum amounts that a retirement plan account owner (e.g., 401(k) or IRA) must withdraw starting the year that he or she reaches 72 (401(k) RMDs can be deferred if you are still working and not a 5% or greater owner of your employer).
In other words, a retirement plan owner cannot sit on their money forever. They must begin withdrawing a Required Minimum Distribution starting at age 72.
The government allows you to postpone paying taxes on tax deferred retirement accounts until the funds are withdrawn. However, you cannot defer the taxes forever. RMDs are the government’s way of ensuring taxes are collected.
RMDs apply to tax-deferred retirement plans. These are retirement plans for which the government has never collected income tax. 401(k) accounts and Traditional IRAs are two such examples.
The Federal government does not tax the funds when deposited into these accounts. Instead, they tax the funds upon withdrawal. RMDs are taxed as ordinary income.
RMDs ensure that those withdrawals occur.
RMDs apply to all tax-deferred retirement accounts, including:
The amount of an RMD is based on IRS-published “life-expectancy tables.”
The specific factor that applies to you can be found on the IRS website here.
For example, a 78-year-old in 2022 has a life expectancy of 22 years. Therefore, his or her RMD is calculated by dividing the prior year-end (12/31) account value by the applicable life expectancy factor (22). A different IRS table is used if the spouse is greater than 10 years younger than the account owner.
If you are already withdrawing money from your retirement accounts before age 72, you still must abide by RMD rules after age 72.
For some retirees, their withdrawals are already above RMDs. Those retirees will not have to increase their distributions.
Other retirees are withdrawing money, but it’s less than RMDs. Those retirees will have to increase their distributions to the RMD for their age.
When someone passes away, their retirement account goes to the named beneficiaries or to the estate if no beneficiary is named.
Inherited IRAs are subject to RMDs, but the specific rules vary by the type of beneficiary. For example, a spouse can treat an IRA as their own and take RMDs based on their life expectancy. But an adult child inheriting an IRA must follow the “10-year rule” for RMDs, which states that the beneficiary must liquidate the account (and pay subsequent income taxes) within 10 years of the account owner’s death.
RMDs are an important factor in long-term financial planning, since they dictate both retirement income and tax burden.
For example, suppose a retiree was planning on selling a rental property they own, thus incurring a capital gain. Would they want to pay capital gains taxes during the same year in which they are forced to take an RMD, which may increase their federal tax bracket? Probably not!
Proper planning would encourage them to pay the capital gains taxes before RMD age.
These scenarios highlight why RMDs are a key part of long-term financial planning. Consider a Qualified Charitable Distribution (QCD) as a way to manage RMDs and the associated tax liabilities.
For more information on RMDs and tax planning, contact your financial advisor.
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