After a certain age, individuals with retirement accounts must withdraw a certain amount from these accounts each year as a minimum. This withdrawal is known as a required minimum distribution, or RMD, and it typically becomes mandatory at age 73.
Key Takeaways
- Required minimum distributions are the minimum amount you must withdraw from your tax-deductible retirement accounts.
- These withdrawals are required by law after the age of 73.
- RMDs can be donated to reduce or eliminate the tax burden created by the additional yearly income.
- The amount of an RMD is determined by the total value of your qualifying retirement accounts and factors like age, beneficiaries and the original owner of the retirement account.
What Does RMD Stand For and When Does it Start?
Required minimum distributions have been a part of retirement planning in the United States since the mid-1970s with the introduction of IRAs as a new type of long-term investing mechanism. These withdrawals are required by statute for all types of retirement accounts except for Roth IRAs and certain similar types of accounts.
Most people with retirement accounts must start making these withdrawals at age 73, but there are some exceptions to this rule. You aren’t technically required to make your first withdrawal from your retirement accounts until April 1 of the year following your 73rd birthday, for instance. Qualifying charitable contributions from your retirement accounts are also counted toward your RMD, meaning you can offset some or all of your required withdrawal with certain philanthropic contributions.
What If I’m Still Working?
There are also RMD exemptions for individuals who are still working at the company sponsoring their retirement plan, as long as they own less than 5 percent of the company administering the account. This allows people who continue to work past the minimum retirement age to take full advantage of the benefits offered by an IRA or similar account.
What Accounts Require RMDs?
RMDs are required for many types of employer-sponsored retirement plans. The most common types of accounts subject to RMD rules are:
- Traditional IRAs
- Rollover IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k)s
- 403(b)s
It’s worth noting again that Roth IRAs, Roth 401(k)s and other types of Roth accounts are not subject to the same RMD requirements as these retirement plans.
How to Determine RMD Amount?
How much you’ll need to withdraw from your accounts each year is calculated by dividing each account’s balance as of Dec. 31 by a life expectancy factor calculated using tables provided by the IRS. These life expectancy factors are determined based on a number of factors relating to you, your beneficiaries, and the original owner of the retirement account.
How to Handle Multiple IRAs
RMDs are calculated for each individual account—if you have more than one IRA, you will need to calculate the RMD for each one based on all the factors considered by the IRS. Once you’ve determined your total RMD for the year, however, you can withdraw that amount from any one IRA or combination of accounts as long as the total withdrawal meets or exceeds your minimum requirement.
How are RMDs Taxed?
Assuming all of your retirement account contributions were tax-deductible, the income gained by withdrawing your RMD will be treated like any other income and taxed accordingly.
In some cases, an individual might make contributions to an IRA or other retirement account that are not tax-deductible but are still subject to an RMD after age 73. In these cases, you will need to work with the IRS or your tax professional to determine how much of your RMD income must be taxed and how much is exempt for the year.
How to Use RMD Assets
Funds withdrawn from your retirement accounts through an RMD can be used in a variety of ways, and some of these uses can help reduce your tax burden or make the assets more useful to your beneficiaries.
Reinvest the funds
One common use for RMD funds is to reinvest the money elsewhere simply. This can help protect the money from inflation and continue to make it work for you even once it’s no longer in a tax-protected retirement account.
The only caveat to this approach is that the funds cannot be placed back into a typical retirement account—if they are made using RMD funds, the investments must be made into a taxable form of investment account.
Donate to Charities
Charitable donations are another common use of RMDs, and if they’re done correctly, you can avoid paying taxes on some or all of the money withdrawn for the year. Donations made to charitable organizations directly out of your RMD funds are called qualified charitable distributions, or QCDs, and up to $100,000 of these funds each year can be omitted from your taxable income.
Support Education for Your Family
If you have young family members planning to go to college, a 529 education savings plan might be a good use of your RMD funds each year. These savings plans allow your money to continue to grow tax-free and will remain tax-deductible as long as the funds are used for a qualifying educational expense in the future.
Bottom Line
While an RMD can seem confusing at first, especially if you’re recently retired or haven’t had to make withdrawals from your retirement accounts yet, the process is relatively straightforward and doesn’t have to be a financial burden if done correctly. By using your withdrawal wisely through reinvesting and charitable contributions, your RMD can become an opportunity rather than a burden each year. At Horizon Wealth Management, we can help you ensure your financial future is clear with retirement planning services and financial planning services. Schedule a discovery call today!
RMD FAQs
What is the biggest RMD mistake?
Probably the most common mistake people make with their first RMD is failing to withdraw the correct amount or missing the withdrawal deadline. These errors are sometimes accompanied by substantial fines from the IRS, but they can be easily avoided by working with a qualified investment professional to ensure the process is followed correctly and in a timely manner.
Is it better to take RMD monthly or annually?
In the long term, there is little difference if any in an individual’s finances if they choose to withdraw their RMD monthly, quarterly or annually. This decision should be made based on an individual’s needs and personal preferences, and will likely be informed by what other forms of income, if any, the person has.
Do RMDs affect Social Security or Medicare premiums?
RMDs do not directly impact social security payments but can affect Medicare premiums. If your RMDs raise your tax bracket, this can have a secondary effect on the amount of taxes paid on social security income and the Medicare surcharge premiums calculated based on your Modified Adjusted Gross Income.
