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As Ben Franklin said, “… [n]othing is certain but death and taxes.” Required Minimum Distributions (RMDs) are the method the IRS uses to ensure that you pay some taxes on your pretax retirement savings. They’re pretty straightforward, but there is a catch here and there.

 

What accounts are subject to RMDs?

To paraphrase George Carlin, Uncle Sam loves you and he needs money! Required withdrawals are generally only taken from retirement accounts that have pretax funds in them, with one exception. Because you haven’t yet paid any taxes on that money, you need to start taking money out to provide the government with some income tax revenue.

Traditional IRA, SEP and SIMPLE IRAs, and 401(k)-like accounts, such as TSP and 403(b)s, are subject to required minimum withdrawals. However, if you reach RMD age while you’re still working at the company whose 401(k) you currently contribute to, you don’t need to start taking them as long as you own less than 5% of the company. If you have 401(k)s from previous companies, however, you’ll need to take RMDs from them.

Since you paid taxes on your Roth contributions, you won’t have to take any money out of your Roth IRA. That’s for both contributions and conversions, because either way you already paid your taxes. Roth conversions often make sense in certain years with lower tax brackets, and to “fill up” your tax bracket. You get the added benefit of reducing the size of your Traditional account and thereby reducing required income in addition to accumulating more tax-free money.

The one exception for Roth accounts is for 401(k)s and similar employer retirement accounts (though not SEPs and SIMPLEs). Roth 401(k)s are subject to the same rules as the Traditional 401(k). Even though it’s after-tax money, RMDs are still the rule. Unless you’re still working for the company whose 401(k) you’ve been contributing to, in which case you don’t have to begin at age 72.

It’s easy to avoid this particular complication. Just roll your Roth 401(k) money into a Roth IRA instead. A direct rollover has no tax consequences, and you’ll eliminate the RMD from that account.

 

How much am I required to take out?

Fortunately, you’re not the one who has to calculate the amount! The financial institution that holds your retirement account will tell you how much you need to withdraw. If you have multiple accounts, the institution calculates the amount for each account.

The requirement is based on the account balance as of the previous December 31 and your life expectancy factor taken from IRS tables. The beginning requirement is usually around 4% of the balance, and the percentage increases as you age.

 

Which accounts can I use to satisfy the RMD requirement?

The money must come from a pretax retirement account in your name. The IRS doesn’t keep track of the individual amount that you owe, just the aggregate amount.

For example, suppose you have three IRAs at different brokerage firms. The RMDs are $2,000 on one, $3500 on another, and $1500 on the third so the total withdrawal is $7,000. You can take the entire amount from one account or split it up between them all, whichever makes sense for your financial plan.

We recommend consolidating accounts, especially retirement accounts. Fewer accounts makes keeping track of your RMDs much easier. If you miss a withdrawal, the penalty is pretty steep.

 

When do I have to start my RMD’s?

For many years, the starting age was 70 ½. That was changed during the last administration to age 72, and RMDs were waived for the 2020 tax year in the CARES Act, due to the coronavirus.

If you are age 72 or older you need to start your distributions (subject to the caveats noted in question 1). For the first year of RMDs, you can delay your distribution until April 1 of the following year. For every other year, you’ll need to make the withdrawal by December 31 of that year.

It’s usually not a good idea to delay your first withdrawal. If you don’t take it in the year you turn 72, then you’ll have two required withdrawals the next year: the one you were supposed to take at age 72 plus your RMD for age 73. The option is available to you in case there is some reason that it makes sense.

 

Is there any way I can avoid RMDs?

There’s no legitimate way to avoid the required withdrawals once you’re age 72 and no longer working for the company you were contributing to. However, you can avoid paying taxes on up to $100,000 of your RMD by using the Qualified Charitable Deduction or QCD.

Sending a withdrawal from your retirement account directly to the qualified charity of your choice satisfies your distribution requirement, but you don’t owe taxes since it’s a charitable donation.

The QCD strategy only works if the money comes from an IRA, because it doesn’t count from an employer retirement plan. In addition, the funds must leave the IRA institution and be sent immediately to the charity (a nonstop transfer). Any donation that makes a stop at your bank account loses QCD eligibility.

 

What if I don’t take my RMDs for the year?

The IRS levies a pretty hefty penalty of 50% of the RMD if you elect not to take it out, or on the portion that you didn’t withdraw if you did take some out.

Unless you can prove that you didn’t know you had to take it and you never received the notification from your financial institution, you’ll owe that penalty.

 

What happens if I die in the year I start my RMDs?

Your beneficiaries are required to take the required withdrawals by the end of the year (December 31), even if it’s the year you turned 72. Each of the beneficiaries has to take their proportional share, no matter if another beneficiary takes more than their share.

For example, suppose your RMD is $1,200 and you have four beneficiaries. Each one must take $300 before December 31, even if another beneficiary already took out the full $1200.

If your beneficiary is a trust or the estate, the trust (or estate) must make the withdrawal before December 31.

If you have questions about consolidating your accounts or potentially reducing your RMD exposure, please give us a call at 619.255.9554 or send us an email to set up an appointment.

 

 

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