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

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'll need to take into account the changes put in place by the SECURE Act 2.0, which extended the RMD start age.

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

A required minimum distribution (RMD) is a minimum amount you must withdraw from qualifying retirement plans once you reach a specific age.

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, including Roth 401(k)s*
• 403(b) plans, including Roth 403(b)s*
• 457(b) plans, including Roth 457(b)s*
• Profit sharing plans
• Other defined contribution plans

*Even though Roth 401(k), Roth 403(b) and Roth 457(b) plans are listed as subject to RMDs, that requirement will be eliminated in 2024.

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.

With the passage of the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) and then the Strong Retirement Act of 2022 (SECURE Act 2.0) in 2023, the age has changed as follows:

• If you turn 73 before 2033, your RMD age will be 73.
• If you turn 74 after 2032, your RMD age will be 75.
  

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, use one of three tables provided by the IRS:

• Uniform Lifetime Table – for all unmarried IRA owners calculating their own withdrawals, married owners whose spouses aren’t more than 10 years younger, and married owners whose spouses aren’t the sole beneficiaries of their IRAs
• Table I (Single Life Expectancy) is used for beneficiaries who are not the spouse of the IRA owner
• Table II (Joint Life and Last Survivor Expectancy) is used for owners whose spouses are more than 10 years younger and are the IRA’s sole beneficiaries

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.

RMDS will be taxed as ordinary income in the year that you take them, so it's possible the additional income from your distribution could push you into a higher tax bracket. However, there are some opportunities that can eliminate the tax or defer when those RMDs must begin, that we will discuss later.

The IRS requires you to take your RMDs. If you don't, the IRS imposes a 25% tax penalty (this was reduced by the SECURE Act 2.0 from the previous 50%) 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 give you a $1,250 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 receive a $750 penalty for the amount you didn't take—and you still need to withdraw the remaining $2,000. 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 within the Correction Window* and include a letter explaining your situation and any actions you took to fix your errors.

You may think that once your RMD age 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:

If you're still working after your RMD age 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.

You may choose to do a Roth conversion from your employer or a traditional IRA, which is taxable.¹ However, you must withdraw your RMD for the year prior to converting. Once the funds are in the Roth IRA, they're no longer subject to RMDs. You can always access your contributions tax-free. And, if you're over age 59½ and have owned the Roth IRA for at least five years, you can withdraw earnings tax-free.

A qualified longevity annuity contract (QLAC) can help provide income in retirement. With this approach, you move a portion of your savings from tax-deferred accounts into a deferred annuity that meets specific IRS requirements. 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.

In 2023 and 2024, you can invest up to $200,000 of a retirement account into a QLAC to shield those funds from RMDs.

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 $105,000 per year (which will be indexed for inflation each 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.

People age 70½ and older can also give a one-time gift of up to $53,000:

• Gifts can go to a charitable remainder unitrust (CRUT), charitable remainder annuity trust (CRAT) or charitable gift annuity (CGA).
• For the gift to count, it must come from your IRA by Dec. 31.

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.

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.

Longevity is a part of any long-term retirement plan. No one knows when they'll pass away. However, having a strategy for how to distribute your savings during 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.