Laura reviews six RMD rules you should know and factor into your retirement planning.
Laura reviews six RMD rules you should know and factor into your retirement planning.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
Have a money question? Send an email to money@quickanddirtytips.com or leave a voicemail at 302-365-0308.
Find Money Girl on Facebook and Twitter, or subscribe to the newsletter for more personal finance tips.
Money Girl is a part of Quick and Dirty Tips.
Links:
https://www.quickanddirtytips.com/
https://www.quickanddirtytips.com/money-girl-newsletter
https://www.facebook.com/MoneyGirlQDT
https://twitter.com/LauraAdams
If you want to become wealthy, an essential habit you should create is regularly investing a portion of your income in a tax-advantaged retirement account. You may have an excellent option at work, like a 401(k) or 403(b). If not, there are individual retirement accounts or IRAs and self-employed retirement plans you can open and contribute to on your own.
The years you have to invest money for the future is called the accumulation phase. But at some point you’ll want to take money out, or be forced to take it out, in some cases, which is the withdrawal phase of life.
This post will review the rules for taking required minimum distributions or RMDs from retirement accounts. I’ll review six rules you should know and factor into your retirement planning, no matter your age.
Welcome back, everyone! I really appreciate you joining me for Money Girl episode 874! I'm Laura Adams, an award-winning author, female finance spokesperson, money speaker, founder of The Money Stack, a Substack newsletter, and host of Money Girl with over 43 million downloads.
If you're getting value from the free content we love creating, subscribe and consider submitting a 5-star rating or review on your podcast app of choice! If you have a question about money for the show, leave it on our voicemail at 302-364-0308. You can also send an email and sign up for the free Money Stack newsletter at LauraDAdams.com.
What are required minimum distributions (RMDs)?
Required minimum distributions are annual minimum amounts you must withdraw from certain accounts starting the year you reach age 73 or 75, starting in 2033. They continue for your entire life or until an account is depleted.
The purpose of RMDs is ensuring you pay income taxes on balances not previously taxed. Distributions are subject to ordinary income taxes, not the capital gains rate, which applies to earnings outside a retirement account, such as a brokerage account.
You can always withdraw more than the required minimum, but failing to withdraw what’s required results in a penalty, with a few exceptions I’ll cover in a moment.
6 required minimum distribution (RMD) rules
Here’s a summary of six RMD rules you should know.
1. Tax-deferred accounts have RMDs.
You must take RMDs from any tax-deferred account, including a:
If you receive an upfront tax deduction on an account, the government ensures you (or your heirs) will eventually pay tax on the entire amount through RMDs.
RELATED: How does a SEP-IRA work?
2. After-tax accounts don’t have RMDs.
Since you make after-tax contributions to accounts like a Roth IRA and Roth 401(k), they’re not subject to RMDs. After 59.5, withdrawals of contributions and earnings from a workplace Roth or a Roth IRA are entirely tax-free. If you don’t wish to use the funds, you can keep them growing tax-free indefinitely or pass them to your heirs.
READ ALSO: Is it better to have a traditional IRA or Roth IRA?
3. Workplace retirement plans have an RMD exception.
If you have a retirement plan at work, such as a 401(k) or 403(b), there’s an important RMD exception. If you’re not ready to retire by age 73 (or 75, starting in 2033) and still work for an employer where you have a retirement plan, you don’t have to take RMDs.
As long as you don’t own more than 5% of the company where you work, you can generally delay the requirement to take distributions from a traditional retirement plan until you decide to retire.
In some cases, the rules may permit you to still be considered employed for the purposes of this exception, even if you’re part time. Check with your retirement plan administrator to understand what’s allowed.
Note that the still-working exception doesn’t apply to retirement accounts for individuals or the self-employed, such as a traditional IRA or a solo 401(k), or retirement accounts you have with previous employers.
RELATED: What’s the difference between a 401(k) and a solo 401(k)?
4. RMD amounts change every year.
The most confusing part about RMDs is how they’re calculated. Your annual required withdrawal for each year is based on the balance in your account on December 31 of the previous year and on your longevity, using an IRS table in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).
The table gives you different life expectancy factors every year to divide into your account balance and the result is how much you must withdraw. For example, let’s say you’re 72, have $500,000 in a traditional IRA, and have a life expectancy factor of 27.4. This year you’d need to withdraw $18,248 ($500,000 / 27.4).
As I’ve mentioned, you can withdraw more, but you can’t apply an excess toward the RMD requirement for future years.
Your retirement account custodian typically lets you know the amount of your RMD and sends out Form 1099-R to report the distribution. Setting up an automatic monthly or quarterly RMD withdrawal plan can help you stick to a budget.
5. Accounts can be subject to different RMD rules.
The RMD rules vary a bit if you have multiple retirement accounts. For instance,if you have more than one 401(k), you must calculate and withdraw your RMD separately from each of them.
But if you have multiple IRAs, you can determine your aggregate RMD. For this rule, you can include all types of IRAs, including traditional IRAs, SEP-IRAs and SIMPLE IRAs. This rule is why many people choose to rollover their 401(k) to an IRA.
Once you know your aggregate IRA amount, you can take it from your IRAs in any ratio that you want by the end of the year. For instance, you could take the total from just one IRA until it’s depleted and then draw down the next IRA. Or you could split up the total by taking it from multiple IRAs in the same year.
Interestingly, the aggregation rule also applies when you have more than one 403(b) plan. However, you can’t aggregate multiple 401(k)s or 457 plans, nor can you combine different types of retirement accounts, such as an IRA and a 403(b) into one RMD.
READ ALSO: What should I do with an old 401(k)?
6. Not complying with RMDs is expensive.
Many investors begin taking retirement distributions when they claim Social Security retirement benefits, which can be as early as 62. You can make penalty-free withdrawals from any type of retirement account after you reach age 59½.
As I mentioned, unless you qualify for an exemption, you must take RMDs after you turn 73, whether you need the money or not—so don’t forget the deadline to comply.
Your first RMD must be taken by April 1 of the year after you turn 73. First-timers get a one-time extension. If you use it, you must also take your second withdrawal by December 31 of the same year, which means you’ll have an oversized tax bill. So, consider taking your first RMD by the end of the year you turn 73 to spread out your taxable income over multiple years.
As I mentioned, you can always withdraw more than the minimum required amount. But if you miss the deadline or withdraw too little, you must pay income tax, plus an additional 25% penalty, on the amount you failed to withdraw.
However, if you correct an RMD error within two years, the penalty drops to 10%. And in some cases, if you can show that you’ve made a good faith effort to resolve an RMD error, the IRS may waive the penalty.
What should you do with RMDs you don’t need?
If you’re fortunate enough not to need an RMD, there’s plenty you can do with it. You could reinvest it in a regular, taxable brokerage account, put it in a bank savings or CD, or spend it on anything you like.
If you’re feeling generous, you could use funds from an RMD to pay for a child or grandchild’s education. If you contribute it to a 529 college savings plan you may qualify for a state income tax deduction, depending on where you live.
Charities would love to receive your RMD as a qualified charitable distribution (QCD). A QCD is a nontaxable distribution up to $105,000 (or $210,000 if you file a joint tax return), paid from your IRA directly to a qualified charity. If you’re in a position where you must take RMD money you don’t need to spend, consider using it to make a difference in the lives of family, friends, or even total strangers.
Before we go, here's a quick reminder to subscribe to The Money Stack, my weekly newsletter, when you visit LauraDAdams.com. It's filled with money tips, tools, news, challenges, and things I enjoy! You can subscribe for free or become a paid member with access to live educational events.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team!
Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.