As if Required Minimum Distributions (RMDs) weren’t confusing enough, there have been recent tweaks to the tax code from The SECURE Act, The SECURE Act 2.0 and the CARES Act. So, if you’re close to retirement age, you probably have a lot of questions about this topic (and you’re not alone). In this episode of The Agent of Wealth Podcast, host Marc Bautis does a deep dive into RMDs.
In this episode, you will learn:
- What a Required Minimum Distribution (RMD) is.
- How a Required Minimum Distribution (RMD) is calculated.
- Why learning about RMDs now is important, even if you’re years away from your 70’s.
- RMD planning opportunities that can mitigate the impact of RMDs.
- How The SECURE Act 2.0 changed Required Minimum Distribution (RMD) rules.
- And more!
Resources:
Complete the Checklist | 12 Answers to the Most Asked RMD Questions | Schedule an Introductory Call | Bautis Financial: 7 N Mountain Ave Montclair, New Jersey 07042 (862) 205-5000
Welcome back to the Agent of Wealth Podcast, this is your host Marc Bautis. Today we are going to talk about Required Minimum Distributions, more commonly known as RMDs. It’s a topic that’s top-of-mind for people who took them a couple of weeks ago, just before the December 31st deadline. And, since the recently passed SECURE Act 2.0, I’ve been receiving a lot of questions about them, since the bill made some changes to RMD rules.
And while RMDs mostly impact people in their 70’s, I encourage you to keep listening even if you are years away from taking your first RMD, because there are some planning opportunities that you may want to consider before 70 to mitigate the impact of RMDs.
Another reason to listen in: You may inherit an IRA one day and the rules around Beneficiary IRA’s are complex and frequently changing.
What Is A RMD?
When you have a tax advantaged retirement account like a 401k or IRA, you (or if an employer was putting in money to the account on your behalf) received a tax deduction every year for money you put into the 401k or IRA. The RMD is simply the IRS wanting to collect its tax. They do this by forcing you to take money out of your 401k or IRA, which is then taxed as ordinary income.
And when I say 401ks or IRAs, it could really be any type of retirement account, including:
- Traditional IRAs
- SIMPLE IRAs
- SEP IRAs
- 401k’s
- 403b’s
- 457 plans
- Profit Sharing Plans
- Other Defined Contribution Plans
One account type that’s not included is a Roth IRA. That’s because no withdrawals are required by the government until after the account owner has died. Reason being with a Roth IRA, you didn’t get the tax deduction when you made the contribution. The tax benefit on the Roth is when you start withdrawing funds and don’t have to pay tax on your distribution.
I’ll talk a little more about how Roth’s can be used as an RMD strategy shortly.
How RMDs Are Calculated
Once you find out that you’re subject to RMDs, the next question you’ll have is: What is my RMD?
Generally, an RMD is calculated by dividing the prior December 31st balance of the account by a life expectancy factor that the IRS publishes in Tables in Publication 590-B, Distributions from Individual Retirement Arrangements.
Each year that you get older, your RMD will be a larger percentage of your account balance. But it will never be 100%. As long as you keep living, you can still have funds in your account. At a high level it’s about 4% that you have to take out at age 72 and the percentage goes up from there.
Most people don’t calculate their RMD themselves and have either their financial advisor, CPA, or financial institution where the account is held calculate it for them.
There are also online calculators that you can use.
How The SECURE Act 2.0 Changed RMD Rules
SECURE Act 2.0 was a piece of legislation passed right before the end of the year. It builds on the first SECURE Act, with the goal of further strengthening our retirement system. There were a slate of changes that impacted RMDs, including:
The age at which owners of retirement accounts must start taking RMDs increased to 73, effective January 1, 2023. Prior to 2023, the age to begin taking RMDs was 72. So, individuals will now have an additional year to delay taking a mandatory withdrawal of deferred savings from their retirement accounts.
There are two important things to think about here:
- If you turned 72 in 2022 or earlier, you will need to continue taking RMDs as scheduled.
- If you’re turning 72 in 2023 and have already scheduled your withdrawal, you may want to consider updating your withdrawal plan.
The SECURE Act 2.0 also pushes the age at which RMDs must start to 75 starting in 2033.
Under current law, Roth 401(k)s (unlike Roth IRAs), are subject to RMDs. A provision in the SECURE 2.0 Act eliminates RMD requirements for workplace-based Roth plans beginning in 2024. This change results in Roth 401(k)s having similar treatment related to RMDs as Roth IRAs.
The penalty for failing to take an RMD has decreased to 25% of the RMD amount not taken. Previously, the penalty was 50% of the RMD amount not taken. The penalty will be reduced to 10% for IRA owners if the account owner withdraws the RMD amount previously not taken and submits a corrected tax return in a timely manner.
What You Need to Know About RMDs for Beneficiary IRAs
If you inherit an IRA from someone, the RMD rules are a little different than if you own the account yourself.
If you inherited an IRA, the rules around RMDs fall into 3 categories:
- Spouses.
- Non-spouses.
- Entities (like trusts, estates, or charities).
If you don’t take the RMDs from your account, you will be subject to a penalty equal to 50% of the amount that should have been withdrawn.
If you inherited a Roth IRA, the same rules generally apply – you must take RMDs. However, as long as the assets have been in the original Roth IRA owner’s account for 5 years or more, you can make tax-free withdrawals.
Beneficiary IRAs: Spouses
If you inherited an IRA from your spouse, you have the choice of either moving the money into your own IRA or into an inherited IRA.
Option 1: Move the money into your own IRA
If you consolidate the money into your IRA, then the regular RMD rules apply.
Can be advantageous if:
- You have not yet reached age 72 but your spouse had. It enables you to stretch out the tax-deferral of IRA assets by delaying distributions until you reach age 72.
May not be advantageous if:
- You are under age 59½, and you intend to take a distribution from your IRA. You will be subject to the 10% early withdrawal penalty in your IRA.
Option 2: Move the money into an inherited IRA
If you move your money into an inherited IRA, you withdraw RMDs based on your age. RMD amounts are based on your age and are recalculated each year based on factors in the IRS Single Life Expectancy Table. There is no 10% withdrawal penalty, so it’s also something to consider if you need immediate access to cash.
Beneficiary IRAs: Non-Spouses
Distribution requirements will be based on the date of the original account owner’s death.
If the account owner died in 2019 or earlier, you have the ability to take RMDs based on your age using the IRS Single Life Expectancy Table.
If the original account owner died in 2020 or later, in most cases you will need to fully distribute your account within 10 years following the death of the original owner.
However, there are exceptions if you are considered an eligible designated beneficiary. Eligible designated beneficiaries include a minor child of the original account owner, a disabled or chronically ill individual, or any other person who is not more than 10 years younger than the deceased account holder. If you are an eligible designated beneficiary, you can still withdraw RMDs based on your age.
Beneficiary IRAs: Entities
If the beneficiary is an entity, charity, or non-qualifying trust, and the owner was still living by April 1 of the year in which the account holder reached age 72, the distributions would be based on the remaining Single Life Expectancy of the IRA owner. If the owner was younger than 72, the assets must be completely distributed by December 31 of the 5th year containing the anniversary of the IRA owner’s death.
Ways to Mitigate the Impact of RMDs
A lot of the people I work with are subject to RMDs, and I have yet to meet anyone who likes the concept of RMDs. The reason being that no one likes to be told what to do, especially when it comes to their money, and especially when it’s the government telling them what to do.
So naturally, I’m frequently asked how an individual can avoid having to take an RMD. Or, how they can avoid paying tax on their RMD.
The government is pretty smart, and strict… but here are a couple of options you can consider.
Roll a Portion of The Money In Your IRA to a Roth IRA
When you rollover any of your funds from a traditional IRA, 401k, or other tax-advantaged account into a Roth through a conversion, you pay taxes on the funds you convert at your ordinary income rate. Now, this could lead to a substantial tax bill, but the advantage of doing this is that the taxes are done. You won’t need to take RMDs, nor will you need to pay taxes on any distributions you take after making the conversion.
Note that there are rules around Roth distributions you have to meet to ensure they are tax-free.
Continue Working
If you have a 401k, 403B or other small business retirement plan, you do not have to take RMDs starting at age 73 if you are still working and do not own more than 5% of the business. In this situation, you can wait to take your first RMD until April 1st in the calendar year after you retire.
Now, this only works for your current employer’s plan. If you have a traditional IRA or a 401k from an old company you worked at, you will still need to take your first RMD at age 73.
Consider a Qualified Longevity Annuity Contract (QLAC)
If you don’t need the funds from your RMD, you can use some of the money in your 401k or IRA to purchase a qualified longevity annuity contract, or QLAC. You are limited to contributing a maximum of $135,000 to a QLAC and you cannot contribute more than 25% of any particular retirement account to fund your QLAC.
Marry Someone Younger
This may sound like a joke, but the IRS allows you to use different life expectancy tables depending on the ages of both you and your spouse. If your spouse is more than 10 years younger and is the sole beneficiary of your IRA, you’ll use the Joint Life and Last Survivor Expectancy Table, which allows you to withdraw a smaller amount in RMDs each year.
Donate the Money to Charity
If you don’t need the money to supplement your retirement income, you have the option to donate all – or part – of your RMDs directly to a charitable organization by taking a qualified charitable distribution. The IRA must send the money directly from your account to the qualified charity. You can then exclude the amount of the charitable contribution from your taxable income.
Time Your First Distribution Correctly
You can wait until April 1st of the calendar year after you turn 73 to take your first RMD. Some retirees wait to take their RMD because they think they’ll be in a lower tax bracket that year. However if you do wait to take your first one you’ll have to take your second RMD by December 31st of that same year.
To help with planning around RMDs, we have a checklist that you can use when reviewing your RMD. Here are some of the things to consider:
- Is the RMD enough to cover your living expenses?
- Are you eligible for any exceptions?
- Is the value of your qualified account significantly up or down, due to market conditions?
- Can you earmark your RMD as a method of withholding taxes?
- Does a Roth conversion make sense?
- Can you make a Qualified Charitable Deduction (QCD)?
Thanks for tuning into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.
Bautis Financial Advisor Commentary: January 26, 2023