What you need to know about minimum distributions required – Forbes Advisor

It makes sense to use tax-efficient investment accounts to save for retirement. By investing money in a traditional 401 (k) or individual retirement account, you can defer paying taxes on your retirement funds for what can seem like forever.

But postponement doesn’t mean you can avoid them forever; Uncle Sam ends up getting his share. For retirement investors who are fortunate enough to have saved a nest egg in an IRA or 401 (k), the bill is due in the form of Minimum Required Distributions (RMDs) that begin at age 72.

What are RMDs?

RMDs are mandatory withdrawals that you must make from your traditional individual retirement account (IRA) or traditional or Roth 401 (k). The exact amount you need to withdraw depends on your retirement account balance and your life expectancy, which we’ll discuss in more detail below.

Since any withdrawal involving money that has not been taxed before (i.e. anything in a traditional retirement account) generally needs to be taxed when you withdraw it, RMD is used to make sure that you eventually pay taxes on your retirement funds. Otherwise, you could let your money stay where it is, allowing it to keep piling up while avoiding higher income taxes.

For this reason, “RMDs are probably one of the biggest complaints I hear from clients,” said Desmond Henry, a certified financial planner (CFP) in Topeka, Kan. they feel penalized by them.

But whether they like it or not, by April 1 of the year after your 72nd birthday at the latest, you need to start withdrawing funds and paying the IRS what’s owed.

How to calculate RMD

Generally speaking, RMDs are calculated taking into account your life expectancy and your total retirement account balance subject to RMD (i.e. essentially all funds not held in a Roth IRA).

Depending on your marital status and the age difference between you and your spouse, you will need to find the life expectancy factor that applies to you by using one of the The three available IRS tables. You will then take that number and divide your eligible RMD balance by it.

Here’s an example: A 75-year-old is assigned a life expectancy factor of 22.9, according to the Uniform Lifetime Table. (This is the guide that most people whose spouses are no more than 10 years younger than them will use to calculate RMDs.) So, a 75-year-old with $ 200,000 in an IRA should receive a distribution of $ 8,734 that year. That’s about 1/23 of their savings.

An 80-year-old man with $ 200,000, on the other hand, has a payout period of 17.9, which means he would have to withdraw $ 11,173, a higher amount because he theoretically has fewer years to go. reset this balance to zero for tax purposes.

What’s the best way to take RMD?

The best way to take RMD is determined by your personal situation, but here are two things to consider. You may want to leave the money in your retirement account until December 31 of a given tax year to maximize returns on your investment.

Alternatively, you may prefer to take your RMD in equal portions throughout the year – say 12 monthly installments – to avoid synchronizing the market and providing you with a consistent retirement check. This is essentially an inverted average cost in dollars.

While you and your financial advisor can use the numbers to determine the best time to make your withdrawal, ultimately the best way to take an RMD comes down to what is best for you. That said, you’ll want to make sure you withdraw at least the minimum by the end of the year because …

There is a big penalty for getting the wrong RMD

Never skip an annual RMD. The IRS levies a huge penalty for this: 50% of the amount that should have been withdrawn. If you should have taken $ 9,500 and you didn’t, the IRS will levy an excise tax of $ 4,750, well above the income tax bill.

And, no, you can’t make up for missing withdrawals in the coming years or get credit for previous excessive withdrawals. The RMD must be taken in that tax year.

Can you avoid RMD or at least relieve the pain?

To answer briefly, no and then yes. The bill for the tax relief offered by all tax-advantaged retirement accounts is finally coming due. There really is no way around this. But there are a myriad of ways to tinker with the charges. Here are a few :

Donate to charity with a QCD

Once you’ve calculated your RMD, you can donate up to $ 100,000 to the IRS-approved charity of your choice through Qualified Charitable Distribution (QCD). Why give it away? The RMD will not add a dime to your tax bill and you will do the world good.

Just be careful: if you accept the distribution yourself and don’t give it until later, you could still end up paying taxes. A direct distribution from the account to the charity is superior for tax purposes.

Use the work exemption again

Employees who do not retire at age 72 are exempt from RMD… but the exception only applies to money saved in their current employer’s plan. Those approaching the age of 72 and considering this strategy would be wise to consolidate their retirement funds into their current work plan.

Delay RMDs with a QLAC

Using funds from a traditional IRA or a traditional 401 (k) to purchase a Qualified Longevity Annuity Contract (QLAC) can potentially lower your RMD.

A QLAC is a form of deferred annuity, and you can defer QLAC annuity payments up to age 85, thus deferring the tax bill on some of your retirement funds for an additional decade or more beyond age 72. This is not a permanent solution, but it keeps some of your savings away from RMD and tax for a while.

Avoid RMDs with a Roth Conversion

Roth IRAs are the only tax-advantaged retirement account that does not have an RMD. (Even Roth 401 (k) must be transferred to Roth IRA to avoid RMD.)

After you retire, but before the RMD maturity date reaches age 72, you have a potential window of opportunity to use a Roth conversion, which is probably the most effective and most effective strategy. no longer under-utilized to process RMD. Here’s why:

Most people see their income drop immediately after retirement, making this a great time to convert from a Traditional or 401 (k) IRA to a Roth IRA while in a lower tax bracket.

“Of course, this strategy does not come without warning,” Henry said. “First of all, you should know that transferring pre-tax money from a retirement account to a Roth IRA means that you pay tax on those funds.” Also, you should be careful not to increase the portion of your Social Security benefits that is subject to federal income tax or trigger the IRMMA, the Medicare Supplements Tax.

As with any complicated financial maneuver, the best policy is to consult a financial advisor before pursuing this particular strategy.

Save your RMD in a Roth IRA

Since most retirees eventually have to take RMDs, consider taking the money you were forced to withdraw and saving it in a Roth IRA. It won’t help you avoid income taxes related to RMD, but at least you will feel better knowing that the money can then grow tax-free and RMD-free until you or your successors in really need.

The last word on MSY: plan ahead

When you start working, you make a deal with Uncle Sam: To help you build your retirement savings faster, you can get tax relief and avoid paying the type of capital gains tax. that you would have in a taxable investment account. However, customers often forget about this compromise, Henry said. “I like to remind them that Uncle Sam always has his share; it’s just a matter of when, ”said Henry. Fortunately, there are strategies to delay or even minimize the tax impact.

If you can start thinking about your retirement planning early in your career, consider forgoing the immediate tax relief of a traditional IRA or regular 401 (k) and putting some of your money in. a Roth IRA. These funds will never be subject to federal taxes or RMD. And, if for some reason you are unable to employ this strategy, consider any of the above tactics to minimize the potential pain of RMD later in life.