Avoid Penalties Associated with Required Minimum Distributions

Time is running out to make sure mandatory withdrawals from your retirement account(s) are made before the end of the year to avoid steep penalties. Different types of accounts come with different requirements, and understanding which accounts carry certain requirements is critical to avoiding penalization.

Defining Required Minimum Distributions (RMD)

Required minimum distributions – RMD for short, are mandatory annual withdrawals that must be taken in the year you reach age 72 (up from 70 ½ prior to the passage of the SECURE Act). Traditional and Roth 401(k), and other workplace retirement plans, as well as most individual retirement accounts, are subject to RMD rules. Roth IRAs are the one exception, with no required withdrawals until after the account owner’s death.

One extreme to another

A large proportion of retirees withdraw more than their required to due to the need for more income while others need a regular reminder. If you are the latter, it is of the utmost importance to be sure that you are following the rules associated with the different accounts. Ignoring or overlooking these rules could carry up to a 50% tax penalty on the amount that should have been withdrawn.

Determining RMD amounts

The annual RMD is generally determined by dividing the specific account’s balance on December 31 of the previous year by an IRS-defined “life expectancy factor”.

The new life expectancy tables from the IRS reflect longer lives making RMDs slightly lower as a percentage of your balance than if tables from before 2022 were used.

Be mindful of the rules as they apply to your accounts

Those with multiple accounts carrying RMD requirements may have different options, depending which types of accounts you hold.

• For IRAs, the total of each RMD can be taken from just one of your IRAs, or in any combination you choose. This also applies to traditional IRAs, as well as SEP and SIMPLE IRAs. This DOES NOT apply to inherited IRAs.
• For 401(k)s, the RMD must come from each account subject to the withdrawal.
• For 403(b) accounts, you may aggregate RMDs similar to IRAs.

First year of RMDs

Say you turned or are turning 72 this year, you are permitted to delay the first RMD until as late as April 1 of the following year, however, in doing so you would take two RMDs in 2023. In taking two RMDs in 2023 you would be “bunching” income, which could carry its own tax consequences.

Taking an RMD in 2022 and the following year will be more beneficial, lowering your taxes in each year and avoiding consequences for “bunching”.

RMDs are not handled jointly for spouses

Each person may aggregate their RMD amounts and make withdrawals from one specific account as permitted but may not combine RMD amounts with their spouses and take distributions from just one spouse’s account.

Required minimum distributions from a 401(k) may be delayed if you are continuing to work for the company that is sponsoring it, but must still be taken for other 401(k) accounts.

Stock may be used as an RMD ‘In-Kind’

Having enough cash on hand or liquidity to fulfill your RMD is always best, but if you need to utilize your stock holdings, distributions may be taken ‘in kind’.

This strategy is performed by transferring stock from your tax-advantaged IRA to a brokerage or other taxable investment account. Taxes would be paid on the amount transferred, but you would have satisfied your RMD and still retain ownership of the stock.

Review your portfolio to avoid unintended tax consequences

Now that you have an understanding of how RMDs work and are aware of different requirements for different types of accounts, it is a great time to review your accounts and determine the specific requirements for each.

Meeting with your tax planning specialist before the end of the year allows you to prepare for tax filing season and puts you in the best position to avoid potentially heavy future penalties.

While it may seem overwhelming, your retirement planning advisor is well-equipped to properly structure your accounts and ensure compliance with any regulations and requirements they may carry.