If you have been saving for retirement, your accounts are likely full of funds. However, your work isn’t over once you retire. You need to understand how everything works to avoid financial mishaps, especially the rules about required minimum distributions (RMDs) from your retirement accounts. Making mistakes with RMDs can lead to fines and penalties, draining your savings faster than expected.
Understanding Required Minimum Distributions (RMDs)
A required minimum distribution is the minimum amount you must withdraw from your retirement accounts each year. The Secure 2.0 Act recently increased the RMD age from 72 to 73. This change means RMDs are now larger, partly due to stock market gains and the increasing number of retirees.
Fidelity Investments, a major financial services firm, expects its total RMDs to hit a record $25 billion this year. According to Rita Assaf, Fidelity’s vice president of retirement products, “Due to the market high on Dec. 31, 2023, and more clients being eligible, we anticipate RMDs in 2024 to be the largest ever.”
If you are turning 73 this year or planning ahead, here are four key facts about RMDs you should know.
Taxation of RMDs
RMDs are treated as ordinary income, so they are subject to federal and state income tax rates. This can increase your adjusted gross income (AGI), possibly pushing you into a higher tax bracket. This might lead to higher Medicare premiums, taxation of Social Security benefits (depending on state laws), and the loss of other tax advantages. Planning ahead and saving for unexpected taxes is a smart idea, especially in the first year.
Penalties for Not Taking RMDs
Avoiding taxes by not taking out the money when you don’t need it isn’t possible. If you fail to withdraw the required amount or miss the RMD deadline, you will face a penalty of 25% on the amount you should have withdrawn. Additionally, you will still have to withdraw the amount and pay taxes on it, along with the fine. However, if you correct the mistake within two years, the IRS may reduce the penalty to 10%.
Inevitability of RMDs
When you turn 73, you must take RMDs by December 31 each year. While you can’t avoid RMDs, you can place the money in a high-yield savings account to earn interest or reinvest it in other assets to continue growing your wealth. Some retirees choose to donate to charity to offset their taxes, which can be a rewarding way to use the money if they don’t need it.
Roth IRA Exemption from RMDs
Roth IRAs do not require RMDs because contributions were taxed upfront. Investment gains within a Roth IRA are tax-free if you are at least 59½ years old and have owned the account for at least five years. RMDs only apply to a Roth IRA if the account is inherited.
Special Considerations
If you are still employed at age 73 and participate in an employer-sponsored retirement plan, you are not required to take RMDs from that plan. However, this exemption does not apply to retirement plans from previous employers. There is an exception: if your current employer’s plan mandates distributions at RMD age or if you own more than 5% of the business where you work, you will need to take RMDs.
Frequently Asked Questions (FAQs)
What is an RMD?
An RMD, or required minimum distribution, is the minimum amount you must withdraw from your retirement accounts each year once you reach a certain age.
When do I need to start taking RMDs?
You need to start taking RMDs at age 73, according to the Secure 2.0 Act.
How are RMDs taxed?
RMDs are treated as ordinary income and are subject to federal and state income tax rates.
What happens if I don’t take my RMD?
If you don’t take your RMD, you will face a penalty of 25% on the amount you should have withdrawn. This penalty can be reduced to 10% if corrected within two years.
Are Roth IRAs subject to RMDs?
No, Roth IRAs are not subject to RMDs because contributions were taxed upfront. However, RMDs apply if the Roth IRA is inherited.
Understanding RMDs is crucial to avoid penalties and manage your retirement funds effectively. As you reach 73, ensure you withdraw the required amounts, plan for taxes, and consider your options for reinvesting or donating the funds. Staying informed and prepared will help you make the most of your retirement savings.