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What you need to know about RMD rules, requirements & penalties

CHRIS OZER

When thinking about money and retirement, much of the focus is on saving, like building up a nest egg to last throughout your retirement. But once you hit retirement age, your attention may move to thoughts of how to maximize what you've saved for the long term.

If you have qualifying retirement accounts, you may want to pay attention to the new required minimum distributions (RMDs) regulations. Knowing the RMD rules can help you start planning around when you need to take withdrawals. You also may want to keep an eye out for the potential passing of the SECURE Act 2.0, which may extend the RMD start age.

Understanding these rules can help you develop a strategy and plan for retirement.

What is an RMD?

required minimum distribution is a minimum amount you must withdraw from qualifying retirement plans once you reach a specific age. Through 2019, you had to start taking RMDs once you hit 70½. However, with the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2020, the age moved to 72.

Except for Roth IRAs (while the owner is still living), retirement accounts have RMDs. The IRS requires RMDs for the following plans:

  • Traditional individual retirement accounts (IRAs)
  • Simplified Employee Pension (SEP) IRAs
  • Savings Incentive Match Plan for Employees (SIMPLE) IRAs
  • 401(k) plans
  • 403(b) plans
  • 457(b) plans
  • Roth 401(k) plans
  • Profit sharing plans
  • Other defined contribution plans

In most cases, RMDs are taxed. That's because when you contribute to your 401(k) plan you use pretax dollars, so the IRS imposes RMDs to help pay that deferred tax. However, you can make after-tax contributions, which aren't taxable upon withdrawal. Also, although Roth 401(k)s are subject to RMDs, the distributions may not be taxable if they're qualified distributions, which are tax and penalty-free withdrawals. The taxes you pay on your RMDs are at your current tax bracket.

How the SECURE Act changed the RMD rules

Americans are spending more time in retirement than ever before. According to the Social Security Administration, the average woman turning 67 today can expect to spend another two decades enjoying retirement. That makes it increasingly important to have a long-term plan to help your retirement savings last.

The SECURE Act changed the RMD rules on distributions from age 70½ to 72 beginning in 2020.

Depending on the market and your investments, that extra time may help the money in your retirement accounts grow tax-deferred for a little longer. However, if you turned 70½ before 2020, the traditional rules apply. RMD withdrawals stay at age 70½ for you.

How to calculate your RMD

The IRS has a worksheet to help calculate your RMD. The formula starts with the balance of your IRA at the end of the previous year. Then, using one of three tables—uniform life expectancy (most commonly used), single life expectancy, and joint life and last survivor expectancy—find your age on your birthday this year on the proper table. This number is your distribution factor. Finally, divide your account balance by your distribution factor to get your RMD.

RMDs can increase with age. It ultimately depends on your account balances, age and life expectancy.

Tax implications to consider

When planning when to take your RMDs, there are two dates to pay attention to. First, if you turned 70½ in 2020 or later, you must take your first RMD by April 1 of the year after you turn 72. After that, you must take future distributions by Dec. 31.

Taking multiple RMDs in one year may have tax implications. Remember, your RMDs are taxed at your current income, so it's possible the additional income from your distribution could push you into a higher tax bracket.

Review the scenarios and discuss your best option with a tax professional. For example, depending on your situation, you may find it's best to take one RMD the year you turn 72 versus pushing it back until the following year and needing to pay taxes on two RMDs.

Penalties for not taking an RMD

The IRS requires you to take your RMDs. If you don't, the IRS imposes a 50% tax penalty on the amount you haven't withdrawn on top of the income taxes you already owed for the required amount. For example, if you've determined your RMD is $5,000 and you don't take it, the IRS may hit you with a $2,500 penalty.

The same is true if you only take a portion of your RMD. If you have a $5,000 RMD and withdraw only $3,000 of it, you may get a $1,000 penalty for the amount you didn't take, and you still have to pay taxes on the $5,000. If you're worried about penalties, speak with your financial advisor. Many custodial accounts automatically calculate and withdraw RMDs for you.

There are some exceptions to this rule. If you made an honest mistake and forgot or made an error calculating your RMD amounts, you can ask the IRS to waive the penalties. To do so, fill out Form 5329 and include a letter explaining your situation and any actions you took to fix your errors.

How to potentially reduce your RMDs

You may think that once 72 hits, your only choices are to take your RMDs or pay a steep tax penalty for avoiding them. But you have some options to reduce or even avoid RMDs while still staying within the IRS guidelines.

Discuss some of these potential options with your financial advisor:

Ask about delayed distribution options

If you're still working after you turn 72 and don't own more than 5% of the company, your employer may offer a delayed distribution option. That may help you postpone taking an RMD from your qualified employer-sponsored plan until retirement. But if you have any other qualifying IRAs, you still need to take RMDs on those.

Make the most of Roth IRA rollovers

You may choose to do a Roth conversion from your employer or a traditional IRA, which is taxable. However, you can't roll over an RMD that's required for the year. Once the funds are in the Roth IRA, they're no longer subject to RMDs. If you're over 59½ and have owned the Roth IRA for at least five years, you can take distributions from this account tax-free. That can help reduce some of your RMD burdens.

Consider a qualified longevity annuity contract (QLAC)

qualified longevity annuity contract (QLAC) can help provide income in retirement. A QLAC allows you to delay RMDs on a portion of your assets until you're 85. The IRS doesn't count the money put into the QLAC with the rest of your IRA balances. However, once the payments kick in, they're taxed.

Donate to a qualified charity

Another option to help reduce your RMDs is to consider charitable donations. You may decide to donate your RMD to a qualified charity through the qualified charitable distribution (QCD) rule. Your donation isn't limited to your RMD amount, you can donate up to $100,000 a year and your donation counts toward your RMD. Keep in mind that it's only allowed for traditional IRA RMDs, not 401(k)s, and the charity must be qualified by the IRS.

Make an in-kind transfer

You aren't required to withdraw your RMD in cash, so you may want to consider an in-kind transfer, where you move your RMD's worth of shares from an IRA account to a brokerage account. This is still considered a taxable distribution based on the market value of the shares at the time of transfer. Also, remember you may lose a portion of your investment if the market goes down.

Learn the younger spouse rule

Another IRS rule may help you if you're married to someone at least 10 years younger who is also the sole beneficiary to your IRA. The younger spouse rule allows you to use a different distribution factor in your RMD calculations (Table II). Since it meets your ages at an intersection, the distribution factor should be higher than it would be on your own, helping to reduce your RMDs.

Keep an eye on the SECURE Act 2.0 RMD implications

Currently, Congress is debating the SECURE Act 2.0. While one version passed the House of Representatives in 2022, the Senate is still discussing a slightly modified bill. If the SECURE Act 2.0 passes, it could impact the age range to begin RMDs moving forward and tax penalties.

For example, with the House of Representatives version of the SECURE Act 2.0, RMD withdrawal ages could increase to 73 in 2022, 74 in 2029 and 75 in 2030. The Senate's version of the SECURE Act 2.0 keeps the current RMD withdrawal age and increases the age to 75 in 2032. It also proposes waiving RMDs for people with less than $100,000 in total retirement savings and reducing the penalty for not taking an RMD from 50% to 25%.

While this act hasn't moved forward yet, there's broad bipartisan support for it in Congress, so it may be something to look out for in the coming years.

The bottom line

A part of any long-term retirement plan is longevity. No one knows when they'll pass away. However, having a strategy around how to distribute your savings to enjoy your retirement can help strike a balance between enjoying retirement and having your money last. Discuss your retirement ideas with a financial advisor, and they can help you determine the best path for your needs.

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Connect with a local financial advisor for your retirement planning needs, including navigating the rules and regulations around required minimum distributions.

Thrivent and its financial advisors and professionals do not provide legal, accounting or tax advice. Consult your attorney or tax professional.

Hypothetical examples are for illustrative purposes. May not be representative of actual results.

There may be benefits to leaving your account in your employer plan if allowed: You will continue to benefit from tax deferral; there may be investment options unique to your plan; fees and expenses may be lower; plan assets have unlimited protection from creditors under federal law; there is a possibility for loans; and distributions are penalty-free if you terminate service at age 55+. Consult your tax professional prior to requesting a rollover from your employer plan.

Distributions of earnings are tax-free as long as your Roth IRA is at least five years old and one of the following requirements is met: (1) you are at least age 59½; (2) you are disabled; (3) you are purchasing your first home ($10,000 lifetime maximum); or (4) the money is being paid to a beneficiary.

State tax rules may differ from federal rules governing the tax treatment of Roth IRAs, and there may be conflicts between federal and state tax treatment of IRA conversions. Consult your tax professional for your state's tax rules.
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