Key Updates About Required Minimum Distributions (RMDs)
What are RMDs?
Once you reach age 72 (formerly age 70 ½ before the SECURE Act was passed in 2019), you are required to take minimum distributions from your traditional IRAs, SIMPLE IRAs, SEP IRAs, Solo 401(k)s and most other employer-sponsored retirement plans. (RMDs are not required from an employer plan if you are still working at the company sponsoring the plan and you do not own more the 5% of the company.) You can always take more than the required amount if you choose.
The portion of an RMD representing earnings and tax-deductible contributions is taxed as ordinary income. Owners of Roth IRA accounts do not have to take an RMD. Since qualified Roth withdrawals are tax free and earnings continue to grow tax free, we often advise that Roth IRA funds be held longer than funds in other types of accounts.
Inherited IRAs (both traditional and Roth) have different rules on when and how much RMD needs to be taken. For example, some RMDs must be taken based on a different life expectancy table than owned IRA accounts and some need to be taken within 10 calendar years after the original owner’s death. Failing to take the full amount of an RMD could result in a tax penalty of 50% of the difference between the required and actual distributions.
Generally, RMDs must be taken by December 31 each year. For owned (not inherited) accounts, you can delay your first RMD until April 1 following the year in which you reach RMD age; however, you will then need to take two RMDs in one year – the first by April 1 and the second by December 31. You may want to weigh the decision to delay your first RMD carefully. Taking two distributions in one year might bump you into a higher income tax bracket for that year.
New Life Expectancy Tables
The IRS publishes tables in Publication 590-B that are used to help calculate RMDs. To determine the amount of a RMD, you would divide your account balance as of December 31 of the previous year by the appropriate age-related factor in one of three available tables.
Recognizing that life expectancies have increased over the years, the IRS has issued new tables designed to help investors stretch their retirement savings over a longer period. These new tables will take effect for RMDs beginning in 2022. Investors may learn that calculations could result in lower annual RMD amounts than expected and potentially lower income tax obligations as a result.
Although very simplified, one might use the RMD requirement as a budgetary guideline on what to withdraw out of your investment accounts upon retiring and collecting Social Security. For example, at age 72, the RMD amount using the Uniform Lifetime Table (used for most owned accounts) is 3.65% of your Dec 31 account balance. This gradually increases to 4.07% at age 75, 4.96% at age 80, 6.25% at age 85, and so forth.
If you have several retirement accounts, you might be able to take one RMD from one account that represents multiple accounts. For example, if you have one or more traditional IRAs and a SIMPLE IRA (or a SEP IRA), you can take one RMD from one account that represents the total RMDs. Most employer plans, such as 401(k)s and 403(b)s must take its own RMD. You can roll over such employer plans to IRA accounts but any required RMD of that plan during the year of rollover must first be taken out of the employer plan. Inherited IRAs must generally take its own RMD (e.g., you can’t combine with traditional owned IRAs or inherited IRAs from other deceased persons).
When during the year to take RMDs
Although individual situations will vary, if owners and inherited account holders need funds close to the RMD amount to cover their expenses during the year, we usually suggest taking RMDs out early in the year. If a monthly budget is followed, spreading out the RMD equally over 12 months could be a suggested withdrawal plan. For individuals in later years of life or having failing health, the full RMD is often suggested to be taken early in the year to simplify estate settlement if one passes later in the year. Some account holders that do not need to use all the RMDs for living expenses during the year may want to take some or all of the RMDs later in the year to continue the tax deferred growth and/or decide late in the year on certain charitable distributions. RMD funds can go directly to a linked bank account or to a linked taxable investment account where excess funds can be reinvested for long term goals.
Consider QCDs before taking the full RMD
For those charitably minded with other sources of income to cover expenses, taxpayers age 70½ or older can make direct donations from a traditional (taxable) IRA account to a qualified (501c) public charity up to $100,000 in total in anyone year. These are called Qualified Charitable Distributions (QCDs) and such withdrawals are excluded from taxation. With the possible exception of SIMPLE/SEP IRAs that are no longer being contributed to, QCDs cannot come from employer sponsored retirement plans such as a 401(k) or a 403(b). For those having to take taxable RMDs, you can count the QCD as part of your RMD, and this distribution would not be included as taxable income on your tax return. Tax form 1099-R(s) will normally come from your custodian(s) early in the year following all your IRA distributions. Since such tax forms do not back out QCDs, it is important to report your QCDs to your tax professional that will be able to show a lower taxable amount on your return than what is shown on your 1099-R tax form(s). You do not report the QCD as a charitable deduction on a Schedule A (for itemized deductions) as this would be double-dipping. Since many taxpayers do not have enough total deductions to itemize, QCDs have become a popular tool to get a tax break when supporting charities with sizable donations after RMDs are required.
Should I withhold taxes from my RMD?
We always suggest you consult with your tax professional for official tax advice. Tax professionals often suggest withholding federal and state taxes from taxable IRA distributions to reduce the risk of penalties from underpayment of taxes and to possibly avoid having to file quarterly estimated taxes. Depending on how much we know about your overall tax picture we may provide some feedback on possible withholdings for you to discuss with your tax professional.
Peak Asset Management, LLC does not provide specific tax or legal advice, and makes no warranties with regard to such information and results obtained by its use. Peak Asset Management, LLC, disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information provided. We encourage you to review all your tax or legal questions with your CPA or Attorney.
Peak Asset Management, LLC is an SEC registered investment adviser. This is not an offer to buy or sell securities. Past performance is not indicative of current or future performance and is not a guarantee. The information set forth herein was obtained from sources which we believe to be reliable, but we do not guarantee its accuracy.
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