Required Minimum Distributions (RMDs) are a key consideration in pre-retirement financial planning. Understanding RMD rules and exceptions will help you plan a more secure financial future without putting a dent in your nest egg.
Introduction to Required Minimum Distributions (RMDs)
A Required Minimum Distribution is the minimum withdrawal, based on life expectancy and age, that you must take annually from your retirement accounts to avoid incurring penalties. This setup ensures retirement accounts are not used indefinitely and allows the IRS to collect taxes on the funds you’ve accumulated over time.
What is the required minimum distribution RMD rule?
The rule states that you must annually withdraw at least the minimum calculated amount from each of your tax-deferred retirement accounts after reaching a certain age.
Importance of Required Minimum Distributions in Retirement Planning
Ensuring consistent income during retirement means planning for RMDs as part of your retirement planning—or finding ways to minimize these tax implications.
Timely RMD withdrawals will help you stay in compliance with IRS regulations and avoid the 25% penalties incurred if you fail to pay or don’t pay on time. You should generally begin taking RMDs at age 73. The age threshold will increase to 75 in 2033.
Generally, you’ll take your first RMD on April 1 for the year you turn 73. After that, RMD withdrawals are required to be made by December 31 each year, based on the account balance for the previous year. Your RMD percentage increases annually based on life expectancy.
Avoiding taking RMDs that increase your taxable retirement income requires planning. Consider using the Tax Corridor when there are no IRS penalties for withdrawal (age 59.5 to 72) by converting money from your tax-deferred retirement accounts into Roth accounts. You will owe taxes on the converted money, but will also shield your funds from RMDs later.
Speaking with a financial advisor can help you determine if this is the best course of action for you.
Inheriting an IRA: RMD Considerations
Most inherited IRAs are still subject to RMD rules, but there are exceptions. Spousal and non-spousal beneficiaries have different inherited IRA rules. Spouses can treat the account as their own, withdraw the entire balance, or start paying RMDs when deceased account owners (who had not yet paid their first RMD) would have turned 70.5.
If RMDs have already begun, the spouse can transfer, open an inherited IRA, or take a lump sum distribution.
Non-spousal beneficiaries can withdraw the entire inherited balance within 5 years after the year of death, or pay RMDs calculated with IRS rules. If RMDs were already being paid, beneficiaries can open an inherited IRA or take a lump sum distribution.
The 10-Year Rule for Inherited IRAs
Most beneficiaries will need to withdraw the full account balance within 10 years, following the year of death of the original account owner. Age does not apply, and there are no early withdrawal penalties. The distributions are taxed as regular income.
Inherited IRAs can pose a tax hike problem for heirs, who are typically in their top earning years when these accounts are inherited. Taking large distributions can cause a beneficiary to move into a higher tax bracket.
Exceptions to the 10-year rule are Eligible Designated Beneficiaries:
- Minor children
- Surviving spouses
- Mentally ill or disabled beneficiaries
- Beneficiaries less than 10 years younger than the decedent
Strategies for Managing RMDs
Failing to take RMDs on time is one of the most damaging mistakes you can make with your tax-deferred account, resulting in costly penalties. If you don’t take your RMD on time, significant penalty of 25% will be applied plus the income tax on the distributions taken.
Plan your withdrawals before retirement age to minimize the tax impact once you enter retirement, when they could have detrimental effects on your tax bracket. Converting IRA funds to Roth accounts between ages 59.5—72 can shelter the money from RMDs later. Or, use Qualified Charitable Distributions (QCDs) to satisfy RMDs. Once you reach 70.5, this rule allows you to donate up to $105,000 to charity annually.
Getting guidance from a financial expert can help you uncover strategic ways to strengthen your financial future and get ready for retirement. Are you ready to take control of your retirement planning and ensure you’re making the most of your RMDs? Reach out to MyStages® today for a personalized consultation.
