Saving for retirement is a big achievement, but your work isn’t over just because you’re retiring. Now, you need to make sure you understand how your retirement savings work, especially when it comes to required minimum distributions (RMDs). If you make mistakes with RMDs, you could face fines and penalties that reduce your savings faster than expected.
What Are RMDs?
A required minimum distribution (RMD) is the smallest amount of money you must take out of your retirement accounts every year once you reach a certain age. Recently, the Secure 2.0 Act changed the age for RMDs from 72 to 73, which means the RMDs will be larger now. This change happened because of record-high stock market gains and more people retiring.
For example, Fidelity Investments predicts that its total RMDs will hit a record $25 billion this year. According to Rita Assaf, vice-president of retirement products at Fidelity, this increase is due to the high market on December 31, 2023, and the growing number of clients who now need to take RMDs.
If you’re turning 73 this year or planning for the future, here are four important things you should know about RMDs.
Taxes on RMDs
RMDs are considered regular income, which means you’ll have to pay both federal and state income taxes on them. These withdrawals can increase your adjusted gross income (AGI), possibly pushing you into a higher tax bracket, raising your Medicare premiums, and even causing your Social Security benefits to be taxed. It’s important to plan ahead and set aside money to cover these taxes, especially in your first year of taking RMDs.
| Tax Impact | Details |
|---|
| Income Tax | RMDs are taxed as ordinary income. |
| Impact on AGI | Increases AGI, possibly pushing into a higher tax bracket. |
| Medicare Premiums | Higher AGI could lead to increased Medicare premiums. |
| Social Security Benefits Tax | RMDs could result in taxation of Social Security benefits. |
Penalties for Not Taking RMDs
You can’t skip RMDs to avoid taxes. If you don’t withdraw the right amount or miss the deadline, you’ll face a steep penalty of 25% of the amount you were supposed to take out. You’ll still need to withdraw the money and pay taxes on it, plus the fine. However, if you fix the mistake within two years, the IRS might lower the penalty to 10%.
| Tax Impact | Details |
|---|
| Income Tax | RMDs are taxed as ordinary income. |
| Impact on AGI | Increases AGI, possibly pushing into a higher tax bracket. |
| Medicare Premiums | Higher AGI could lead to increased Medicare premiums. |
| Social Security Benefits Tax | RMDs could result in taxation of Social Security benefits. |
The Requirement to Take RMDs
Once you hit 73, you have to take RMDs by December 31 each year. While you can’t avoid taking RMDs, you can put the money into a high-yield savings account to earn interest or reinvest it in other assets. Some retirees choose to donate their RMDs to charity to reduce their tax burden. This can be a rewarding way to use the money if you don’t need it for living expenses.
Roth IRAs and RMDs
Roth IRAs are different from other retirement accounts because they don’t require RMDs. This is because you’ve already paid taxes on the money you contributed. Plus, the investment gains in a Roth IRA are tax-free if you’re at least 59½ years old and have had the account for at least five years. The only time RMDs apply to a Roth IRA is if someone inherits the account after your death.
Special Situations
If you’re still working at age 73 and have an employer-sponsored retirement plan, you don’t have to take RMDs from that plan. However, this doesn’t apply to retirement plans from previous jobs. There’s one exception: if your current employer’s plan requires distributions at RMD age, or if you own more than 5% of the business where you work, you will need to take RMDs.
1. What is a Required Minimum Distribution (RMD)?
An RMD is the minimum amount of money you must withdraw from your retirement accounts each year once you reach a certain age. The amount is based on your account balance and life expectancy.
2. At what age do I need to start taking RMDs?
The age to start taking RMDs has recently changed from 72 to 73 due to the Secure 2.0 Act. You must begin taking RMDs by April 1 of the year following the year you turn 73.
3. How are RMDs taxed?
RMDs are considered ordinary income, meaning they are subject to both federal and state income taxes. The amount you withdraw could also increase your adjusted gross income (AGI), potentially pushing you into a higher tax bracket and affecting your Medicare premiums.
