You diligently saved throughout your working years and may now be approaching the age when it will be mandatory to make required minimum distributions (RMDs). Unless you have your retirement funds in a Roth IRA, which were funded by post-tax contributions, you will be required to distribute the funds and pay tax on the necessary withdrawals. Or perhaps you aren’t approaching your RMD age anytime soon, now is the time to plan and explore possible strategies to increase your retirement funds. This article will focus on the ins and outs of the RMD process and other factors that could affect your RMDs.
What age are RMDs required?
For years the RMD starting age was 70.5 years old. However, through legislation included in the SECURE Act of 2019 and the SECURE 2.0 Act of 2022, the RMD age increased to 72 years (born between July 1, 1949 – December 31, 1950), 73 years (born between January 1, 1951 – December 31, 1959) and then increases to 75 years (born 1960 or later). Please note that the age of 73 will be noted throughout the article, but if you are born in 1960 or later, you will not have to begin RMDs until you are 75 years old.
What accounts are subject to RMDs?
The following accounts are subject to RMDs, and although there are general RMD rules, the rules vary according to the type of accounts, the plan document, employment status, and whether the account was inherited.
Traditional IRAs, SEP IRAs, and SIMPLE IRAs:
For Traditional IRAs, SEP IRAs, and SIMPLE IRAs, RMDs need to begin at age 73. You must take your first RMD by April 1 of the year after you turn 73, and then in the following years by December 31. The rules for these specific plans require you to take RMDs even if you are still working. Also, if you have more than one IRA, you must calculate the RMD for each IRA separately but are allowed to aggregate your RMD amounts for all the accounts and withdraw the yearly required RMD from just one account or a portion from all of them.
401(k) and 403(b) Retirement Plans:
For 401(k) and 403(b) retirement plans, RMDs must begin at age 73 by April 1 of the year after age 73 or the year of retirement, if later. One exception to this rule is if you own more than 5% of the business. Unlike the IRAs discussed above, RMDs must be calculated separately for each individual account and taken individually from each plan. If you are still working, you do not have to take your RMD from your current employer’s plan but will be required to take RMDs from other previous employers.
Profit-Sharing and Stock Bonus Plans:
The RMD rules for profit-sharing and stock bonus plans are similar to Traditional IRA plans. You must start taking RMDs by April 1 of the year after age 73 but can delay RMDs if you are still working for the sponsoring employer and do not own 5% or more of the company.
Traditional Pension Plans:
Traditional pension plans, or defined benefit plans, provide a specific, guaranteed amount by the employer that typically gets paid out monthly or annually. These payments usually satisfy the RMD requirements beginning at 73. You can also delay taking your RMD if you are still working for the sponsoring company, unless you own 5% or more of the business.
403(a) Annuity Plans:
403(a) annuity plans are employer-sponsored qualified annuity or pension-type plans that require RMDs by age 73. These RMDs can be delayed if you are still employed by the plan’s sponsor and do not own 5% or more of the company. If you have an annuitized contract that has been converted into a lifetime or fixed-period income annuity, these payments should satisfy your annual RMD. If it is a non-annuitized plan and it is still growing, you will have to calculate your RMD from the IRS Uniform Lifetime Table (Table III). You also cannot aggregate your RMDs from 403(b) annuity plans.
Governmental 457(b) Plans:
Governmental 457(b) plans are employer-sponsored retirement savings plans available to employees of state and local governments, and some employees of tax-exempt non-profits. RMDs must be taken at age 73 regardless of employment status, and you cannot aggregate your RMDs from several plans.
What accounts are not subject to RMDs?
Roth IRAs and designated Roth accounts in employer plans, including Roth IRAs, Roth 401(k)s, Roth 403(b)s, and Roth 457(b)s are not subject to RMDs because their contributions were made after tax. However, this rule only applies while the original account owner is still alive. Upon the owner’s death, the beneficiary falls under RMD rules specific to inherited Roth RMD rules. This will be covered in another section in this newsletter.
How Are RMDs Calculated?
The RMD calculation is determined by an IRS formula that includes your total account balances as of December 31 of the prior year, your age, your life expectancy, and your beneficiary’s age. Your life expectancy is determined among three types of IRS RMD tables. The IRS Uniform Lifetime Table (Table III) is used by most account owners, including unmarried owners, owners whose spouses aren’t the sole beneficiaries, and owners whose spouses are not more than 10 years younger. IRS Joint Life Expectancy Table (Table II) is used if your spouse is more than 10 years younger than you and is a 100% beneficiary of the account for the entire year because it factors in the longer life expectancy of your spouse. The Single Life Expectancy Table (Table I) is used for beneficiaries who are not the spouse of the IRA owner.
RMD = Account balances ÷ Life Expectancy Factor
Please note that if you take your first RMD the year after you turn 73, you will still have to take the RMD for that year by December 31, resulting in two RMDs in one calendar year. Also note, that if you have more than one IRA, you must calculate the RMD for each IRA separately. As stated earlier, depending on what type of accounts you own, you may be allowed to aggregate your RMD amounts for all the ccounts and withdraw the yearly required RMD from just one account or a portion from all of them. On the other hand, some plans do not allow you to aggregate the amounts among all your plans, and the RMD must be withdrawn from that specific account. Also remember that your employment status may affect your RMDs.
Tax Implications and Penalties:
RMDs withdrawals from Traditional IRAs and employer-sponsored retirement accounts are taxed as ordinary income. This may push you into a higher tax bracket, impact how much of your Social Security benefit is taxable, and increase your Medicare premiums.
In addition, if the correct amount is not withdrawn on time (December 31 each year), a penalty of a 25% excise tax will be assessed on the amount you failed to withdraw. However, this penalty may be reduced to 10% if it is corrected within two years.