Understanding Required Minimum Distributions (RMDs)
As you approach retirement, you might start hearing more about Required Minimum Distributions, or RMDs. These are mandatory withdrawals from certain retirement accounts that the government requires you to take. This doesn’t mean you have to spend the money, but you do need to remove it from the account and pay taxes on it. I think the government is saying, “You’ve enjoyed the benefits of tax-deferred growth long enough; now we want our share.” Understanding how RMDs work and managing them effectively is crucial for maximizing your retirement income and minimizing your tax liability.
Which accounts have RMDs?
Not all account types have RMDs. The following accounts do:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans
- 403(b) plans
- Other tax-deferred employer-sponsored retirement plans
Good news if you have a Roth IRA—there are no RMDs during your lifetime, which can be a great advantage in your planning.
When Do RMDs Start?
Starting in 2024, the age for beginning RMDs is 73. You need to take your full year's RMD by the end of the year you turn 73 or by April 1st of the following year. However, if you delay your first year’s RMD, you’ll have to take two the following year. After that, you’ll need to take your RMDs by December 31 each year. In 2033, the RMD age will shift to 75 for those who haven’t yet begun taking RMDs1.
How Are RMDs Calculated?
The amount you need to withdraw is based on your account balance at the end of the previous year and a life expectancy factor provided by the IRS. The IRS has tables that factor in your age and calculate the amount. To give you an idea, the current RMD amount for someone 73 is 26.6, at 74 its, 25.5, at 75 its 24.6 and it continues to become a larger amount as you age. The math works like this. Let’s say you have $1,000,000 in your IRA and are 73. The factor for that year is 1/26.6 which is 3.75%. $1,000,000 x 3.75% = $37,594. This is the amount that you’d need to distribute from your account1.
How do you take an RMD?
RMDs can be taken in several ways. You can divide the year's RMD by 12 and take a portion each month, which mimics receiving a paycheck. Alternatively, if you don’t need the RMD to live on, you might wait until the end of the year to distribute it, allowing the money to potentially grow tax-deferred a bit longer. You can choose to have taxes automatically withheld when you take your RMD or handle the tax payment at tax season. Once the money is distributed, you’re not required to spend it. Many people reinvest their RMDs into a brokerage account.
The Impact on Taxable Income
RMDs can significantly increase your taxable income, which can have a cascading effect on other areas of your financial life. Higher taxable income can push you into a higher tax bracket, increasing your overall tax liability. Additionally, increased income from RMDs can cause a larger portion of your Social Security benefits to be taxable. It can also affect your Medicare premiums, as higher income can result in surcharges known as Income-Related Monthly Adjustment Amounts (IRMAA). This means that an unexpectedly large RMD can not only increase your tax bill but also lead to higher healthcare costs and reduce your overall retirement income. Roth conversions are one way to manage this. This is a rather long topic that I can’t cover in this post. I wrote a longer more detailed article here if you’d like to read it4.
Strategies for Managing RMDs
Proper planning can help you handle your RMDs and reduce their tax impact. Here are a few tips:
- Roth Conversions: Converting some of your traditional IRA or 401(k) to a Roth IRA can reduce the amount subject to RMDs. I wrote an entire post about Roth conversions—click here to read it3.
- Qualified Charitable Distributions (QCDs): If you’re charitably inclined, consider making QCDs directly from your IRA. You can donate up to $105,000 per year as of 2024, and it counts towards your RMD but isn’t included in your taxable income2.
- Multiple Accounts: If you have several retirement accounts, you can take your total RMD amount from one or more of those accounts instead of proportionately from each.
- Reinvesting RMDs: If you don’t need the RMDs for living expenses, consider reinvesting the withdrawn amounts in a taxable brokerage account or another investment vehicle to keep your money working for you.
- Tax Withholding: Make sure you have enough tax withholding on your RMDs to avoid penalties and interest for underpayment of estimated taxes.
Consult a Professional
RMDs can be complex, and tax laws have changed recently and may change in the future. Talking to a professional can help you navigate the rules and develop a strategy that fits your situation. By taking a proactive approach, you can minimize your tax liability and enjoy a more secure and comfortable retirement.
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3 https://www.investopedia.com/roth-ira-conversion-rules-4770480
4 https://www.ssa.gov/benefits/medicare/medicare-premiums.html
This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this material may not be appropriate for all investors. Steward Partners recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Wealth Manager. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Individuals are encouraged to consult their tax and legal advisors (a) before establishing a Retirement Account, and (b) regarding any potential tax, ERISA and related consequences of any investments or other transactions made with respect to a Retirement Account. Tax laws are complex and subject to change. Steward Partners does not provide tax or legal advice.
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