Taking a Closer Look at Required Minimum Distributions

When you reach 72 years old, the IRS generally requires you to start taking Required Minimum Distributions from your retirement accounts.

The 2019 SECURE Act increased the age at which required minimum distributions (RMDs) must begin from 70 ½ to 72. The change under the Act applies to those who turn 70 ½ in 2020 or later. If you continue to work beyond age 72, you may be able to delay your first required minimum distribution from your qualified employer-sponsored plan such as a 401(k), 403(b) or Profit Sharing Plan in certain instances. Check with your employer for more details. A Required Minimum Distribution (RMD) is the annual amount you’re required to withdraw from your IRA or employer-sponsored retirement plan upon reaching your required beginning date (RBD).

Generally, your RBD is April 1st of the year following the year you attain age 72. If you fail to satisfy the annual RMD requirement for your IRAs or employer-sponsored retirement plan, or you fail to withdraw enough to satisfy the RMD, you may be subject to an excess accumulation penalty imposed by the IRS. ^1,4

The Annual RMD Deadline

Generally, your RMD is due by 12/31 each year, with the exception of your first RMD year. As previously mentioned, your required beginning date for your first RMD year is April 1st of the year following the year you attain age 72 or retire, if later, in the case of a qualified retirement plan like a 401(k). However, keep in mind that, should you elect to postpone your first RMD to the following year, you must take a second RMD in the same year by 12/31. ¹

The IRS imposes a 50% excise tax for a failure to satisfy all or a portion of the annual RMD. For example, if your RMD for a year is $10,000 and you fail to timely withdraw the RMD, you could be subject to a 50% excise tax, or $5,000, in addition to the income taxes due on the RMD, which should be withdrawn as soon as possible. In certain instances, you may be able to apply for a waiver of the penalty if you have first corrected the oversight; taking steps to ensure that you satisfy your RMD each year, such as setting up automatic payments, is the best solution to avoid unnecessary penalties.

Strategically, it might be wise for you to consider taking distributions a few years earlier in order to avoid higher RMDs later that could create a ripple effect by causing a portion of your Social Security benefits to be taxable or cause you to pay higher Part B and D Medicare premiums, referred to as the Income Related Monthly Adjustment Amount. By taking distributions before you turn 72 years old, you may also be able to avoid pushing your income into a higher bracket. ^1,4

How Much to Withdraw?

If you own more than one Traditional IRA, SEP IRA, or SIMPLE IRA, annual RMDs for these accounts must be calculated separately. 401(k) and 403(b) plans are also subject to RMDs. The IRS does give you some leeway about how to withdraw your RMD. You can withdraw 100% of your total annual RMD amount from just one IRA, or you can withdraw equal or unequal portions from each of the IRAs you own. However, separate RMDs must be calculated and satisfied from each qualified retirement plan to which you have contributed. For 401(k)s and other defined contribution plans, you must generally take RMDs either when you retire or when you turn 72 years of age, whichever is later. Check with your employer to determine if the plan permits RMDs to be delayed beyond age 72 if you continue to work. However, if you have multiple 403(b) TSAs (tax-sheltered annuities), you can optionally withdraw the sum of all of the RMDs for them from one 403(b) TSA or satisfy each 403(b)’s RMD separately. RMDs for qualified retirement plans must be satisfied separately from the RMD(s) for your IRA(s). If you inherited an IRA, you may still have to take RMDs even if you are younger than age 72. The IRS offers worksheets you can go through to determine RMD. ^2,3,4

Married couples often make the error of thinking they can choose just one partner’s IRA from which to take the RMD, but there’s no such thing as a joint IRA. What this means is that each spouse must satisfy the RMD requirement for the IRAs or employer-sponsored retirement plans they each own.

Tax Considerations

Should You Take Your Minimum Distribution Out All at Once? Keep in mind that money taken out of your retirement savings account is taxable at your highest marginal tax rate. The lower capital gains rate doesn’t apply. The federal tax rate ranges from 10-35%, and your state may impose additional taxes. Required Minimum Distributions receive different tax treatment in different states. Consult with a qualified financial professional for information about your state’s tax laws.

If You Don’t Need The Money... If you don’t need your RMDs to cover expenses, your RMD may be leveraged for tax-efficient planning. Beginning at age 70 ½, you may donate to a qualified charity using money in your IRA. A qualified charitable distribution (QCD) must be transferred directly to the charity and may not exceed $100,000 annually. Executed properly, the QCD not only satisfies an RMD (at age 72 or later) up to the amount of the donation or $100,000, whichever is less, and is also tax-free. Another strategy to consider is using unwanted RMDs to purchase life insurance, which can provide a tax-free death benefit to your loved ones and, in some cases, tax-free income to you during your lifetime. If you are uninsurable, you may also use RMDs to purchase a non-qualified annuity.

Additional Reading:
Required Minimum Distributions - precautions and options.

Tax Issues in Early Distributions from Retirement Accounts

Citations.

1 - bankrate.com/finance/money-guides/ira-minimum-distributions-table.aspx

2 - irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

3 - irs.gov/retirement-plans/irc-403b-tax-sheltered-annuity-plans

4 - waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/SECURE%20Act%20section%20by%20section.pdf