What Is an RMD?

You’ve heard the advice before: First, the earlier you start saving for retirement, the better. Second, if you have access to a tax-deferred account, such as a 401(k) or traditional individual retirement account (IRA), take advantage of the tax benefits they offer.

But the money you put into these accounts can’t sit there forever because you’ll need to start taking what’s known as a required minimum distribution, or RMD. Read on to find out what you need to know about RMDs and how they fit into your retirement planning.

What is an RMD?

An RMD is the minimum amount the government requires you to withdraw each year from any qualified tax-deferred retirement account. A provision of the SECURE 2.0 Act, which was passed at the end of 2022, increased the age at which you have to begin taking RMDs from 72 to 73. This change became effective on January 1, 2023. It will go up again, to 75, beginning in 2033. The change means that if you turned 72 in 2022, you are locked into the old rules, but if you turn 72 in 2023, new rules apply to you.

Because these accounts are funded with pre-tax dollars, you’ll have to pay taxes when taking an RMD. (Note that Roth IRA distributions are generally not taxable, and Roth IRAs do not have RMDs.)

How much do you need to withdraw?

To calculate your RMD, there’s a relatively simple formula to follow. First, tally your retirement account balances as of December 31 the previous year. Then, divide that number by your age’s corresponding life expectancy factor, which you can find in this table. (The IRS also offers worksheets to help you calculate.)

If you have multiple IRAs, you’ll need to calculate your RMD for each separate account. While the separate calculations are mandatory, you can choose to withdraw the total amount from just one IRA. You can also take more than is required, if needed. However, the RMD from an employer-sponsored account such as a 401(k) is calculated separately and the RMD must be taken from that specific account.

What happens if you don’t withdraw?

If you don’t take the full amount of your RMD, you will be hit with a penalty. But, also effective January 1, 2023, the SECURE 2.0 Act reduced that penalty to 25 percent of the amount you were supposed to have withdrawn — down from 50 percent. You will still have to pay the taxes owed.

If you realize your mistake, you will have some time to rectify it: The penalty will be reduced to 10 percent if you correct it by the end of the second year after the year you missed. And for those who can demonstrate the shortfall was due to reasonable error and that reasonable steps are being taken to remedy it, the IRS may waive the penalties.

When do you have to take RMDs?

If you turned 72 in 2022 or earlier, you’ve already reached what’s called your Required Beginning Date.

For those who turn 72 in 2023 or later, new rules apply. You can wait until April 1 of the calendar year after you turn 73 to take your first RMD. Under the new rules, if you turn 73 in 2024, you must take your first RMD by April 1, 2025. After that, you’ll need to make your annual withdrawal by December 31 of each year.

While you can hold off on taking your first payment, it also means taking two withdrawals in 2025 as both your 2024 and 2025 RMDs are being distributed in 2024. This ability to delay the RMD into the following tax year is only available for your first RMD. Delaying the first RMD could push you into a higher tax bracket in that year so you’ll want to talk to a tax professional about what makes the most sense from a tax perspective.

Using RMDs in retirement

Knowing the minimum amount you’ll need to withdraw from your savings each year is an important factor in planning for retirement. In addition to taking the required amount (to avoid a penalty), managing your RMDs can be an important part of tax management in retirement.

• Consider converting a traditional IRA into a Roth. If you convert your traditional IRA to a Roth IRA, you won’t have to take an RMD. However, you will need to pay taxes on the funds in the year that you complete the rollover. A financial professional or tax advisor can help you determine what makes the most sense for your situation.
   

• Start penalty-free withdrawals once you’re eligible. At age 59 ½, you can start withdrawing from your retirement savings without incurring a penalty, but the distributions are taxable. Having a smaller account balance can help offset larger RMDs.

• Roll over your accounts if you’re still working. If you’re still working when you reach your RMD age, you may be able to roll over your IRA into your current employer-sponsored plan. If so, you may be able to hold off taking RMDs from the plan until you retire.

• Receive a charitable deduction if you don’t need your RMD. You may be able to  direct your RMD to an eligible organization as a qualified charitable distribution (QCD). A QCD is not included in your taxable income, and no charitable donation deduction is available.

• Diversify your retirement income sources. Putting all your retirement savings in a 401(k) or IRA may seem like a great idea while you’re saving for retirement. But when you get to retirement, you’ll be required to withdraw that savings and pay tax on it. By using a range of financial options, including Roth accounts, permanent life insurance cash value, nonqualified annuities and more, you’ll have flexibility in retirement to manage your retirement income in a way that can help you minimize taxes and hedge against other potential risks.

Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.