The IRS loves it when you turn 73, but you won’t get a gift or even a card. The Internal Revenue Service can’t wait to get their hands on your hard-earned dollars.
This might be why the IRS is sometimes referred to as the Infernal Revenue Service. Happy birthday and get ready to pay more taxes thanks to three little letters, RMD.
What is a Required Minimum Distribution or RMD?
Required Minimum Distributions or RMDs are amounts that must be taken out of a retirement account each year so the IRS can tax the distribution.
You’ve worked hard and socked away funds tax deferred retirement accounts like IRAs and 401(k) plans. By doing so you’ve deferred taxes on the investment earnings and received a reduction in your taxable income by amounts you contributed each year.
You’ve watched the retirement funds grow over the long term but now that you’re 73, the IRS says it’s time to pay up and prepare to owe tax.
The year you turn age 73:
The SECURE Act 2.0, signed into law in December of 2022, has brought significant changes to the RMD rules. For the last three years, RMDs began the year you turn 72. Now, your first RMD is the year you turn 73. If you’re turning 72 in 2023, you get to wait another year.
Can I postpone my RMD?
The IRS gives you until April 1 of the following year to take your first distribution but requires it be done by December 31 in subsequent years.
If you elect to wait and take your first required minimum distribution by April 1 of the following year, you might end up paying more in tax. Everyone’s situation is different, but you don’t want to go from the frying pan into the fire.
By deferring your first RMD into the next year, you essentially end up taking two distributions in the same tax year. You will need to plan carefully to ensure that you don’t inadvertently increase your income and negatively impact your taxes.
Can I take my Required Minimum Distribution early?
You only need to take the distribution in the year you turn 73 unless you elect to defer until April 1. For example, let’s say you turn 73 in November of 2023. You can take your RMD as early as January 1, 2023. If you take it December 31, 2022, it won’t count so you’ll have to take it for 2023.
When you take a withdrawal from an IRA prior to the year you turn 73, it’s simply referred to as “normal” distribution. Additionally, normal distributions are not subject to penalty but are included in your taxable income.
What if I don’t make the RMD deadline?
Thanks to SECURE 2.0, RMD penalties are now less severe. Historically, penalties for failing to take RMDs were quite stiff. Failing to take the RMD by the deadline would result in a 50% penalty.
Now, that has been reduced to 25%. If the filer identifes the error in a timely manner and corrects their tax return, the penalty may even be reduced to 10%.
If you haven’t taken your RMD, don’t assume the IRS won’t find out. If you have neglected this for several years, consult a tax professional for advice on how best to address the situation.
Calculating the RMD
In general, you need to withdraw an amount based on your life expectancy and retirement account balance as of the prior year. For example, assuming you will take an RMD for 2023, the amount is based on your retirement account balance as of December 31, 2022.
That is fairly straight forward but again, it’s never easy. You will need to determine what life expectancy table to use depending on your situation.
Uniform Lifetime Table
This is used if you are unmarried, married whose spouse isn’t more than 10 years younger, and if your spouse isn’t your sole beneficiary.
Joint Life Expectancy Table
This table is used if your spouse is the sole beneficiary and is more than 10 years younger.
The good news is that your IRA custodian will usually calculate required minimum distributions for you.
However, it is ultimately the responsibility of the IRA owner to make the determination. If you aren’t working with a Certified Financial Planner™ you can visit the IRS website for more information.
Prepare for higher taxes
The main take away here is that the RMD will likely increase each year. You should assume the fair market value of your IRA will increase over time assuming normal investment returns. Additionally, the life expectancy factor is decreasing. That translates to a higher RMD and increased taxes especially for those in a higher tax bracket.
If you inherit retirement funds from as a surviving spouse, you can treat the IRA as your own. This means you operate as though the IRA was yours all along and follow RMD rules accordingly.
However, if you inherit an IRA from anyone other than your spouse, the RMD rules have changed. Non-spouse beneficiaries must fully distribute their inherited retirement account balances within 10 years.
During that time, there are no RMDs, but all funds must be distributed within the 10-year period. This is a significant change from the old rules. Previously, non-spouse beneficiaries could keep the funds invested and take RMDs during their lifetime.
This allowed for continued tax deferred growth of the investments and minimal taxes due to smaller RMDs. Now, significantly higher taxes owed on inherited pre-tax retirement accounts are likely.
Having multiple IRAs:
It is very common to have multiple retirement accounts. Over a working career, it is possible to end up with 401(k), IRA, 403(b), and others.
Let’s assume someone has two IRAs. The RMDs are calculated separately for each IRA but you can take the total amount from just one IRA. The same is true for 403(b) plans.
However, it’s not the case with 401(k) plans. If you have two 401(k) plans, you will need to take the RMD from each 401(k). This is another reason combining redundant accounts together can help streamline and simplify retirement and tax planning.
Roth IRAs are NOT subject to RMDs while the account owner is alive. This is yet another reason Roth IRAs can be a powerful retirement planning tool.
Because Roth IRA contributions are made with after tax dollars, there is no tax deduction taken by the taxpayer in the year the contribution is made. The earnings and growth of the investment are tax free so long as some basic rules are followed.
Because of this, retirement income can be received tax-free, and funds can remain invested long after age 73!
The rules regarding Required Minimum Distributions are complex. Be sure to consult your financial advisor or Certified Financial Planner™ for details on your situation. Start planning because the IRS is looking to throw a big party for your 73nd birthday!
UPDATE: While you’re looking into Required Minimum Distributions, don’t forget about Social Security. One way to get informed is by reading this article called Social Security Spousal Benefits: What You Need To Know from my friend and fellow financial advisor Devin Carroll. Devin is an expert in Social Security who writes and speaks about this subject extensively.
Do you have questions about Required Minimum Distributions and retirement?
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