If you had a piggy bank as a kid — and you didn’t take money out of it every time you wanted some candy from the convenience store up the street — then you might remember how it felt to break it open that first time. The sense of accomplishment from holding your bank full of hard-saved change probably made it difficult to swing that hammer.
This is understandably how many of us feel about the dreaded required minimum distribution (RMD). You work hard over the years to put money away in a tax-deferred individual retirement account (IRA) or employer-sponsored retirement plan. It feels good to watch that investment grow. But unfortunately, the government doesn’t allow your money to stay invested there forever.
Eventually, the IRS comes calling with its own hammer and mandates a certain amount of money that you must withdraw each year from your traditional IRA or employer-sponsored retirement account. This distribution, known as the RMD, is taxable as ordinary income (as if you earned it working).
Here are five things you need to know about required minimum distributions:
1. Who has to take a required minimum distribution?
You may be subject to a RMD if you meet one of the following qualifications:
- You are age 72 or older
- You inherited a traditional IRA before 2020
Generally, people with assets in a traditional IRA or employer-sponsored retirement plan are required to start taking required minimum distributions in the year that they turn 72. If you are still working and have funds in your company’s retirement plan, you can delay this until the first year of retirement (unless you are a 5%+ owner of the company).
If you are the non-spouse beneficiary of an inherited IRA and the previous owner passed away prior to January 1, 2020, you must also take a RMD from the inherited account. Any accounts inherited by a non-spouse beneficiary after the start of 2020 must be completely withdrawn within 10 years, but there is no required annual withdrawal in most cases.
Note: In case you were wondering, RMDs do not apply to Roth IRAs, unless you inherit one from a non-spouse. Also, RMDs do apply to all 401(k) plans, including Roth 401(k) accounts.
2. How is my required minimum distribution calculated?
The RMD amount is based on your account balance at the end of the previous year and, generally, the life expectancy factor provided by the IRS in the Uniform Lifetime Table. To determine the amount, simply divide the balance by the factor for your age. Your RMD will vary each year based on those two numbers.
3. What is the deadline for taking my required minimum distribution?
For your first RMD, you technically have until April 1 of the following year to take the distribution, but then you must withdraw the funds by December 31 for every subsequent year.
4. Can I avoid paying taxes on my required minimum distribution?
Retirees who don’t need the money and are charitably-minded may consider a qualified charitable distribution (QCD) to avoid paying taxes on their withdrawal. A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. Because the funds never touch your hands, the distribution is not taxable and can be a way to optimize your annual gifting.
Note: The maximum annual amount that can be given as a qualified charitable distribution is $100,000 per person.
And while it doesn’t lower the amount of taxes owed, Encompass Wealth Advisors can also help clients avoid the shock of a large tax bill in April by withholding taxes (federal and state) from each distribution.
5. What if I don’t want to spend the money?
While your money can’t stay in your retirement account forever, if you do want to keep the funds invested, you can transfer the after-tax dollars from your RMD to a personal brokerage account to be reinvested.
Solidify Your Retirement Strategy With Encompass Wealth Advisors
Whether you need help navigating required minimum distributions as you approach retirement age, or if you’re earlier on in your career and need a partner in your retirement planning, we’d love to work with you! Reach out to us to learn more about how our team of wealth advisors can help set you up for success in the years to come.