As you approach retirement, you’ve likely worked hard to save and prepare for this new chapter in your life. But even as you retire, there’s more to manage to ensure your savings last. One key aspect is understanding Required Minimum Distributions (RMDs). Making mistakes with RMDs can lead to costly fines and deplete your retirement funds faster than you might expect. Here’s a simple guide to help you navigate RMDs effectively.
What Are RMDs?
Required Minimum Distributions are the minimum amounts you must withdraw from your retirement accounts each year once you turn 73. Recently, the Secure 2.0 Act raised the age for starting RMDs from 72 to 73. This means that if you turn 73 this year, your RMDs might be larger than before. This change is due to higher stock market gains and more retirees now needing to take RMDs.
Taxation of RMDs
RMDs are considered ordinary income, which means they are taxed at regular federal and state income tax rates. This increase in your income could push you into a higher tax bracket, result in increased Medicare premiums, and potentially tax your Social Security benefits. It’s important to plan for these taxes and set aside money to cover them, especially in the first year you start taking RMDs.
Penalties for Not Taking RMDs
Failing to take the required RMDs can lead to a hefty penalty. If you miss taking an RMD or miss the deadline, you’ll face a penalty of 25% on the amount you were supposed to withdraw. You’ll still need to take the RMD and pay taxes on it, plus the fine. However, if you correct the mistake within two years, the IRS might reduce this penalty to 10%.
| Aspect | Details |
|---|
| Tax Treatment | RMDs are treated as ordinary income, affecting your AGI, tax bracket, Medicare premiums, and Social Security taxes. |
| Penalty for Missed RMDs | 25% penalty on the missed amount; can be reduced to 10% if corrected within two years. |
| First RMD Deadline | April 1 of the year following the year you turn 73. |
| Annual RMD Deadline | December 31 each year after the initial distribution. |
The Inevitability of RMDs
Once you turn 73, you must take RMDs by December 31 each year. While you can’t avoid taking RMDs, you have options for what to do with the money. You can deposit it into a high-yield savings account to earn interest or reinvest it in other assets. Some retirees choose to donate the money to charity, which can provide tax benefits and a fulfilling way to use the funds if you don’t need them.
Roth IRA Exemption from RMDs
Roth IRAs do not require RMDs because contributions to these accounts are taxed upfront. Additionally, any investment gains within a Roth IRA are tax-free if you are at least 59½ years old and have owned the account for at least five years. The only situation where RMDs apply to a Roth IRA is if the account is inherited.
| Aspect | Details |
|---|---|
| RMD Requirement | No RMDs for original owners of Roth IRAs. |
| Tax Treatment of Roth IRAs | Contributions are taxed upfront; investment gains are tax-free if conditions are met. |
| Inherited Roth IRAs | RMDs apply to inherited Roth IRAs. |
Special Considerations
If you are still working at age 73 and are part of an employer-sponsored retirement plan, you don’t need to take RMDs from that plan. However, this rule doesn’t apply to retirement plans from previous employers. There’s one exception: if your current employer’s plan requires distributions at RMD age or if you own more than 5% of the company you work for, you will need to take RMDs.
What are Required Minimum Distributions (RMDs)?
RMDs are the minimum amounts you must withdraw annually from your retirement accounts starting at age 73, as mandated by the Secure 2.0 Act. These withdrawals are required to ensure that retirement funds are used during retirement rather than hoarded.
When do I need to start taking RMDs?
You need to start taking RMDs by April 1 of the year following the year you turn 73. After the initial distribution, you must take RMDs by December 31 each year.
How are RMDs calculated?
RMDs are calculated based on your account balance at the end of the previous year and a life expectancy factor provided by the IRS. Financial institutions often assist in calculating your RMDs.
Are RMDs taxable?
Yes, RMDs are treated as ordinary income and are subject to federal and state income taxes. The amount withdrawn is added to your Adjusted Gross Income (AGI), which can affect your tax bracket and potentially increase your Medicare premiums and Social Security taxes.
