To ensure they receive taxes on retirement account gains, the IRS established required minimum distribution (RMD) rules on IRAs and similar tax-deferred savings plans. RMD rules require that account owners begin making withdrawals from certain retirement accounts when they reach 72 years of age.
Without these measures, account holders could potentially let retirement accounts sit to accrue further wealth. If you have other sources of income, you could let these accounts continue earning and then pass them on to your heirs in a tax-exempt scenario. The RMD mandate asserts that you make regular annual withdrawals, ensuring that the IRS receives their taxes.
As a critical component of retirement account disbursements, required minimum distributions rules for IRAs are an important consideration for planning retirement savings. This article will answer common questions about RMDs for IRAs, detailing what to expect when you reach retirement age.
Not all retirement plan accounts require an RMD and those that do have them do not necessarily carry the same rules. The following accounts will have required minimum distributions as part of the IRS’s rules:
Roth IRAs are unique in that they do not require disbursements until the account holder dies. The beneficiaries, however, may face penalties if they do not adhere to RMDs when they take possession of the funds.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was instituted in 2019, changing many of the rules for RMDs. Prior to the change, any person who turned 70 ½ years old before 2020 had to take their first RMD by April 1, 2020. The SECURE Act changed the age requirement to age 72, meaning that if you turn 72 in 2021, the first RMD would need to be taken out by April 1, 2022.
After the first year, RMDs that follow are due by December 31 every year. Account owners must take care to withdraw in a timely fashion, as a delayed payment will force them to make two payments in their first year of RMDs — the distribution due on April 1 and one by December 31. This carries financial risk, as both distributions are counted as income, which could lift you into a higher tax bracket for the year.
The required minimum distribution for IRAs is calculated through two elements — the previous year’s IRA balance and a life expectancy factor established by the IRS. The account balance, or fair market value, is the year-end amount in the IRA. If you are paying your RMD for 2022, it would be based on the IRA’s account balance on December 31, 2021.
The life expectancy component is age-based. The IRS created life expectancy tables for different circumstances to use in calculating your RMD:
A separate table works for inherited IRAs. On the Uniform Lifetime table, each age from 72 on has an associated life expectancy factor, or “distribution period”, ranging from 27.4 to 1.9. The factor decreases as you age.
The RMD is calculated by dividing the IRA’s account balance by the age-based factor. For example, a 75-year-old, will have a factor of 22.9, according to the 2021 table. If they have an IRA with $200,000 in it on December 31, 2021, the calculation would be 200,000/22.9, equaling an $8,733 RMD for 2022.
The RMD is just the minimum required withdrawal amount, so it is perfectly acceptable to withdraw up to 100 percent of the IRA’s value in the first year. However, as IRA withdrawals are taxable income, this will potentially push you up several tax brackets and leave you with a sizable tax bill at year’s end.
The account custodian or administrator will often automatically do the calculations and submit them to the IRS for taxes. However, the ultimate legal responsibility for fulfillment is on the account holder.
Traditional IRA taxes are calculated at the normal income tax rate, with the exception of Roth IRA withdrawals, which are tax-exempt because taxes were already paid on contributions.
If you have several IRAs, you do not have to withdraw separate RMDs from each one. However, you do need to calculate the RMD for each individual account. You can then withdraw that total from a single account or spread it out over several.
To protect against tax abuse, the IRS does require that RMDs from different account types, like 401(k) plans, be calculated and withdrawn separately. Only IRAs can be lumped together for a single distribution. Furthermore, RMD amounts cannot be transferred into a separate tax-deferred account.
The SECURE Act not only pushed the age requirement for distributions but also rules for inherited IRAs. Prior to its passage, inherited IRAs from account holders who passed away before January 1, 2020, had to be distributed within five years after their death.
This changed to 10 years for anyone who passed away after that date, though additional stipulations were included. These rules generally apply to non-spouse beneficiaries.
The SECURE Act established these rules to get rid of stretch IRAs, a strategy that beneficiaries could use to continuously roll IRA amounts into new tax-deferred accounts. However, spouses do have other options available, such as a transfer to their own IRA for continued growth.
Roth IRAs are treated differently. Although Roth IRAs have no RMDs for the account holder, beneficiaries must withdraw a certain amount each year. They are still allowed to distribute funds to a brokerage account rather than withdraw them as cash.
Inherited IRAs are complex, with rules varying depending on the beneficiary’s relationship to the account holder and their physical condition. It is crucial to talk with a financial professional to understand the most advantageous options if you do inherit an IRA.
If an account owner does not take a required minimum distribution by the deadline, they face a 50 percent tax on the funds not withdrawn. They will be required to fill out IRS Form 5329 for that year’s federal tax return to honor their tax obligation. This form, along with an explanation letter, can also be used to waive the penalty if the failure to take out the RMD was due to a reasonable error.
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