Understand Your RMD…Or Else

A couple of weeks ago, I discussed year-end tax moves that investors should consider. However, one move I didn’t discuss at that time warrants its own article.

Three years ago, Congress passed important reforms that can significantly impact those saving for retirement. The Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the SECURE Act, was passed as part of a year-end appropriations and tax bill. The bill’s purpose is to increase access to tax-advantaged accounts.

Key Provisions

Major provisions of the SECURE Act included:

  • Repeals the maximum age for making traditional Individual Retirement Account (IRA) contributions.
  • Raises the age for taking required minimum distributions (RMD) from 70½ to 72.
  • Allows withdrawals from tax-advantaged 529 accounts for up to $10,000 per year in qualified student loan repayments.
  • Allows penalty-free withdrawals of $5,000 from 401k accounts for expenses associated with having or adopting a child.
  • Broadens 401k eligibility to many part-time workers.

The SECURE Act is aimed at the fact that Americans are living longer and they need their retirement savings to last. But today I want to dive into the second bullet item on the list.

Required Minimum Distributions (RMD)

If you are like me, you want to keep the tax advantages of your retirement accounts going as long as possible. Many people postpone taking distributions from retirement accounts as long as they can. But, you can’t postpone them forever.

Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year they turn 72 (or 70 ½ if you reach that age before January 1, 2020), if later, the year in which he or she retires. Thus, one exception to the RMD rules is that you haven’t retired when you hit the age for the RMD.

However, if the retirement plan account is in an IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 72 (again, 70 ½ before January 1, 2020), regardless of whether he or she is retired.

This means — whether retired or not — you must take a minimum specified distribution from an IRA if you turned 72 on or after January 1, 2020. Although you can delay the first RMD distribution to no later than April 1 following the year you reach that age, subsequent withdrawals must be taken by December 31st of each year. If you delayed that first RMD distribution until April 1, you will have to take a second that year.

Following that first year’s distribution, prior to the end of each subsequent year you need to figure out how much you need to withdraw.

How Much?

The exact distribution amount is based on your remaining life expectancy and the value of the account at year-end. The IRA custodian or retirement plan administrator may calculate the RMD, but the IRA or retirement plan account owner is ultimately responsible for calculating the amount of the RMD.

Here’s the really important part. If an account owner fails to withdraw an RMD by the applicable deadline, the amount not withdrawn is taxed at 50%. Thus, this is one of the most important year-end financial moves you need to make if you are subject to the RMD rules.

The IRS publishes rules and tables (Link) to help you understand how much to withdraw. The calculation divides the value of the IRA at the end of the previous year by the remaining distribution period as calculated by the IRS. Different rules apply depending on the age difference of your spouse, or whether you are the sole beneficiary of the IRA.

For example, if your IRA balance at year-end is $500,000, you are 75 years old, and you are not married or your spouse is not more than 10 years younger than you, the calculated distribution period is 24.6 years. See Page 65 of this IRS publication.

You would then divide the balance by this distribution period ($500,000/24.6) = $20,325.20, which is your RMD amount.

Remember that this amount is dependent on the year-end value of your account, which can vary wildly. It’s possible for your RMD from one year to the next to be larger or smaller than the previous year’s.

But whatever you do, don’t forgot to take your RMD, unless you are feeling particularly generous toward the U.S. government. The penalty for taking a late distribution is far greater than the penalty for an early withdrawal from your retirement plan.

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