Retirement planning goes beyond simply saving money. It’s about planning for withdrawal of funds in a way which maximizes your savings as well as reduces tax burdens. A major and important aspect of retirement withdrawals is understanding the concept of Required Minimum Distributions (RMDs).
If you have a tax deferred retirement account, such as an IRA or a 401(k) and the IRS obliges you to take a minimum withdrawal each year when you reach a certain age. In the absence of RMD regulations could result in substantial penalties, while smart planning can reduce taxes and increase the wealth.
In this complete guide, we’ll go over everything you must be aware of about RMDs, including the process they follow and when they begin the process, their tax implications, and strategies to reduce their impact.
What Are Required Minimum Distributions (RMDs)?
RMDs are the mandatory withdrawals of the tax-deferred retirement account that are required to be taken into account when you reach a particular age. The IRS requires these withdrawals in order to ensure that retirement savings are tax-free as the contributions into these accounts were made pre tax.
RMDs are applicable to the retirement accounts that follow:
Traditional IRAs
SEP IRAs
SIMPLE IRAs
401(k), 403(b), and 457(b) plans
Other retirement accounts that are sponsored by employers
However, Roth IRAs are exempt from RMDs for the lifetime of the account’s owner, which makes them an excellent instrument for tax-efficient planning of retirement.
When Do RMDs Start?
From 2023, thanks to the SECURE 2.0 Act, RMDs will start at:
- Age 73 (for individuals born between 1951 and 1959)
- Age 75 (for those born in year 1960 or later)
The first RMD must be taken before April 1 of each year following the RMD age. After that, your RMDs need to be taken each year by the 31st of December.
Example:
If you turn 73 in 2025, your initial RMD is due on April 1, 2026. If you put off the first RMD until April 1st, you’ll be required to file two RMDs in 2026 – one for 2025, and another for 2026. This could potentially increase the tax burden.
If you have a Roth 401(k), RMDs were previously required. However, starting in 2024, the SECURE 2.0 Act eliminates RMDs for Roth 401(k)s.
How Are RMDs Calculated?
The IRS determines your RMD by analyzing two important elements:
1. Your account balance as of December 31 of the previous year
2. The IRS Uniform Lifetime Table, that assigns a live expectation factor dependent on your age
Formula for RMD Calculation:
RMD = Account Balance / Life Expectancy Factor
Example Calculation:
If your IRA balance as on December 31 2024 is $500,000, and your expected life (from table in the IRS Table) is 25.6 Then your RMD to 2025 would be
$500,000 / 25.6 = $19,531.25
RMD Rules for Multiple Accounts
- If you own multiple IRAs you are able to withdraw the entire RMD from any of the accounts.
- For 401(k)s you need to withdraw RMDs from each account.
What Happens If You Miss an RMD?
Failure to take your RMD promptly could cause severe penalties. The SECURE 2.0 Act reduced the penalty from 50% to 25%, and if corrected within a specified period of time, the penalty could reduce to 10%.
Example For example: If you had an RMD was $10,000 and you didn’t take it out, the penalty could be:
- Before SECURE 2.0: $5,000 (50%)
- Now: $2,500 (25%), or $1,000 (10%) if corrected quickly.
To avoid penalties, create reminders to avoid penalties. Set reminders RMD deadlines. Work with a financial advisor to ensure that you are in compliance.
Tax Implications of RMDs
Since RMDs are taxable income, they could raise your tax bracket and impact Social Security Taxation. RMDs are taxed like ordinary income, so they may result in more Medicare costs in the event that your total income is higher than certain thresholds.
Example of Tax Impact
- If your annual taxable earnings is $60,000, and you make $20,000 from RMDs, your tax-deductible earnings increase to $80,000, which could push you into an upper tax bracket.
- If you’re part of Medicare, your income-related monthly Adjustment Amount (IRMAA) could rise and result in higher costs.
To reduce tax burdens, think about strategies such as charity giving, as well as Roth conversions (covered in the next section).
5 Smart Strategies to Reduce RMD Taxes
As RMDs are inevitable it is important to plan ahead in order to minimize their tax impact. Here are five ways to think about:
1. Convert to a Roth IRA Before RMD Age
Since Roth IRAs don’t carry RMDs, converting a portion from your existing IRA as well as 401(k) to a Roth IRA before age 73 could reduce the risk of the chance of having to pay future RMDs.
⚠️ Roth conversions are taxable in the year of conversion—plan strategically with a tax professional.
2. Make Qualified Charitable Distributions (QCDs)
If you’re 70 1/2 years old or older, you are able to make a donation of as much as $100,000 each year out of an IRA to a charity that’s qualified. It counts towards your RMD but it isn’t taxed as income.
3. Delay RMDs with Employer-sponsored Plans
If you work beyond the age of 73, then you might be able to defer RMDs owed by the company’s 401(k) up to the time you are retired. This does not apply if you hold at least 5% or more of the company.
4. Take a withdrawal from tax-paying Accounts First
If you have tax-deductible investment accounts, removing funds from them first could cut down on the future RMD amounts, thereby reducing your tax burden overall.
5. Get in touch with a CPA to develop a Customized RMD Strategy
A Certified Public Accountant (CPA) can assist you in developing an effective withdrawal plan that is in line for your specific tax circumstances which allows you to retain the majority of your funds while still complying with IRS regulations.
Need help with RMDs or planning for a financially secure retirement? Schedule your consultation with us today for expert Elder Planning services in Keller, Texas!
What a CPA can help you with RMDs
Knowing and managing RMDs correctly requires professional advice. A CPA who specializes in retirement and tax planning can assist you:
Make sure you calculate RMDs correctly to avoid penalty.
Plan a tax-efficient withdrawal to lower overall tax.
Use charitable giving strategies to gain tax-savings.
Coordinate the distributions among multiple accounts to ensure greater control.
Be aware of IRS updates as well as SECURE Act changes.
Don’t Let RMDs Drain Your Retirement Savings-Plan Wisely!
In Beck & Ibarra CPA, we assist business and individual owners navigate withdrawals that are tax-efficient, as well as retirement planning with a sense of security. If you need assistance with understanding the RMD obligations, how to minimize taxes or planning the future of your finances, we’re here to assist you through every step of the process.
📞 Let’s Talk! Contact us today for an appointment to discuss your options and take charge of your retirement finances.
