You’re probably familiar with retirement accounts. Your work’s 401(k) or 403(b), or a privately managed Individual Retirement Account (IRA) that you set up yourself. But you might not be as familiar with Required Minimum Distributions (RMDs). RMDs are the minimum annual withdrawal that the IRS mandates from most tax-deferred retirement accounts once you reach a certain age.
From their inception, RMDs began when the account-holder reached the age of 70 1/2. Upon reaching the age of 70 1/2, the account holder had one year to begin taking at least the RMD amount from their tax-deferred retirement accounts each year. With the passing of the SECURE Act in 2019, the RMD age became 72 for anyone turning 72 in 2022. With the passing of the SECURE Act 2.0 in 2022, the RMD age became 73 starting in 2023. Starting in 2033, the age in which a person begins taking RMDs will be 75.
While the concept of RMDs is fairly simple, the implementation is complicated and there are common mistakes that people make. Here are the top five.
- Ignoring or Forgetting the RMD deadline.
Miss your RMD deadline and the IRS will take half of what you should have withdrawn. That’s a 50% penalty for being late.
The deadline is December 31. Every year except the first one, where you have until April 1st of the year after you turn 73. Other than that, it’s end of year. - Incorrectly Calculating Your RMD.
The IRS puts out several tables for calculating RMDs for people of every age, and figuring out which one applies to you can be tricky. And using the wrong table can cause you to take more out than you need or less. Taking out too little would subject you to penalties of 50% of the shortage. Knowing the right one is critical. - Not Understanding the Different Rules for Different Accounts.
Different types of retirement accounts have different rules, including different rules for RMDs. For example, did you know a Roth IRA (where you pay tax on the money going in but don’t pay tax on withdrawals) is not subject to RMDs? Traditional tax-deferred accounts like IRAs and 401(k)s are. Misunderstanding the rules could cause you to withdraw money you don’t need from Roth accounts, or fail to withdraw money from accounts that require it—again subjecting you to penalties. - Overlooking Beneficiary RMD Requirements.
The old rules used to allow most beneficiaries of inherited IRAs to stretch the IRA out, allowing it to grow untouched until they themselves needed it. With the passing of the SECURE Act in 2019, the rules changed and all but a few beneficiaries must now liquidate their inherited IRA within 10 years. Beneficiaries who fail to understand these new requirements could be lining themselves up for severe taxes and penalties. - Failing to Keep Up With Changes.
Lifestyle changes, financial changes, and legal changes can all change when and how a person handles their RMDs. Ignoring the changes or failing to be proactive in the face of changes can render even a well-funded retirement account inefficient due to unnecessary penalties, fees, and taxes.
Whether you have well-funded retirement accounts already or are just getting started on your savings journey, it’s important to understand how things like RMDs can impact your retirement savings and your retirement itself. It’s also important to work with someone you can trust to fill in any knowledge gaps that you may have.
Franklin Retirement Solutions has been working with savers and retirees just like you for more than 20 years. If you have questions, let’s find a time to solve them together. Give us a call at 215-657-9200 or shoot us an email at [email protected].