RMD, or required minimum distribution, is how the IRS generates taxable income from your hard earned retirement nest egg. You cannot keep your retirement assets untouched indefinitely. The RMD law affects those with retirement accounts, excluding ROTH IRAs. Your RMD is the minimum amount you must withdraw from your account each year. After the SECURE Act (Setting Up Every Community Up for Retirement Enhancement) was passed, the RMD age moved from 70.5 years to 72 years of age. Basically if your 72nd birthday is after July 1, 2019 then you don’t have to take your first RMD until April 1 in the year after your 72nd birthday (ain’t that a brain teaser). However, it is not recommended to defer your first RMD to April 1 the following year of your 72nd birthday - for reasons which we will discuss below.
What retirement accounts do the RMD rules apply to?
Traditional IRAs
SEP IRAs
SIMPLE IRAs
401(k) plans
403(b) plans
457(b) plans
profit sharing plans
other defined contribution plans
What are the RMD rules?
You can withdraw more than the minimum required amount. However, the minimum amount must be withdrawn each year by December 31, unless it is the year you turn 72, in which case you don’t have to take your first distribution until April 1 in the subsequent year.
Your withdrawals will be included in your taxable income each year. Your basis after tax contributions in an IRA will not be taxed again, only the capital gains will be taxed (pro-rata rule).
If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.
How do I calculate the minimum I have to withdraw?
Don’t worry, the RMD calculation does not require higher algebra or the utilization of multi-variable vector calculus. In fact, the IRS provides a table called the Uniform Lifetime Table. You take the sum of all your eligible accounts and then divide that number by the value provided on the Uniform Lifetime Table. Let’s break it down: let’s say you are 75 years old, have 1 million dollars in a 401k, 500k in an IRA, and 100k in a ROTH IRA. You’ll see that only the 401k and IRA accounts are eligible in regards to the RMD rules - so we take 1 million plus 500k which equals 1.5 million dollars. We then go to the Uniform Lifetime Table and find that the value provided for a 75 year old is 22.9 (from distribution period column). 1.5 million/22.9 = 65,502.18 which is nearly 4% of the accounts worth. The value provided on the uniform lifetime table continues to increase as your age increases, so a larger and larger percent will dwindle your hard earned savings.
So wouldn’t I want to defer taking my first RMD to the year after to let my money grow longer?
Most likely not. The reason is you’ll get a harder tax hit on your money if you don’t take your first RMD the same year you turn 72 and instead delay until April 1 the subsequent year. Let’s take a closer look: Say you just turned 72 and you have 1 million dollars in an IRA. Your first distribution needs to be 36,496.35. Your second distribution the year you turn 73 will be about 37,735 (assuming the value of 1 million has not changed). If you delay your first distribution to the subsequent year then you will need to take TWO distributions the same year you turn 73 (which will both contribute to (36,496 + 37,735 = 74,231) taxable income and possibly move you into a higher marginal tax bracket). Basically, those two distributions will be added together and possibly move you into a higher tax bracket.
What strategies exist to protect my wealth?
Yes - you can convert pre-tax savings to ROTH and pay the taxes now. Once money is in a ROTH you can leave it to grow until you are deceased. However, once you’re over 72 years old, you cannot convert money into a ROTH until AFTER your full required minimum distribution is taken. So I recommend planning early and converting pre-tax money before you reach 72. Converting pre-tax dollars to a ROTH does not affect your Modified Adjusted Gross Income (MAGI) used to calculate eligibility to contribute to an IRA or a ROTH IRA - you’ll just have to pay the taxes now, but at least you’ll have more control over your assets when you turn 72.
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