Required distributions from retirement accounts have complex rules. To make things even more complicated, recent permanent and temporary legislation about the required minimum distributions (RMDs) have changed the rules even more. Read more for our breakdown on how RMDs work, how recent changes might affect you, and tools to use these distributions to your advantage.
What are required minimum distributions (RMDs)?
Required minimum distributions (RMDs) are the amounts that you must withdraw each year from a traditional IRA, employer-sponsored retirement plan, or tax-sheltered annuity. (Lifetime minimum distributions are not required from Roth IRAs, but your beneficiaries generally must take distributions following your death.) You have to start the annual distributions by April 1st of the year following the year in which you reach age 72. This is known as your required beginning date. If you work for your employer past age 72 and are still participating in the employer’s retirement plan, you may delay your first distribution from that plan until April 1st of the year following the year of your retirement (as long as you are not more than a 5% owner of the employer).1
The beginning distribution age of 72 may sound different than what you have heard previously. Until the end of 2019 with the passage of the SECURE Act, the age was set at 70 ½. If you turned 70 ½ before 2020, then you are still subject to the old rules and must continue to take a distribution each year – even if you’re not yet 72.
After the first year that a distribution is required, you must take annual distributions by December 31st of each calendar year. You’ll continue to take the distributions each year until your death or until your account balance is reduced to zero. You can always withdraw more than the required minimum amount in any given year. However, if you withdraw less than the required minimum, you will be subject to a tax penalty. The required distribution amounts are calculated using the account balances as of December 31st the year prior and life expectancy factor tables.
1Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, required minimum distributions (RMDs) are temporarily waived in 2020.
Why are these requirements in place?
The RMD rules are designed to spread out the distribution of your entire balance in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don’t just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime.
With multiple IRAs, do I have to withdraw money from each one?
If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the total required amount from any one or more IRAs. Since all IRAs are considered to be one from the perspective of the IRS, you have the flexibility to choose from which account or accounts you’ll withdraw the money.2 Inherited IRAs are not included with your own for this purpose. [Similar rules apply to Section 403(b) accounts.] If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.
Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. The distributions are taxed at the earned or ordinary income tax rate. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan. To avoid taxes in this scenario, you must have proof of the after-tax contributions.
For example, if some of your traditional IRA contributions were not tax deductible, those contribution amounts will be income tax free when you withdraw them from the IRA. This is simply because those dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any after-tax contributions. [Special tax rules apply to Roth IRAs and Roth 401(k)/403(b) contributions.]
Are there ways to avoid taxes on RMDs?
One way to avoid taxes on your RMDs is to make tax-free charitable donations directly from your IRA. The distribution does have to be made directly from your IRA to the qualified charity in order to avoid taxation. Up to $100,000 of these Qualified Charitable Distributions (QCDs) are excludable from your gross income each year. The amount of the QCD counts toward satisfying your annual RMD but does not increase your earned income.
What happens when my beneficiaries inherit the account?
Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or beneficiaries) will typically then must take required minimum distributions from the account. A spouse or other eligible beneficiary may have different options available than a non-spouse beneficiary. The recent SECURE Act requires that most non-spouse beneficiaries fully distribute the IRA balance within ten years after inheriting the account.
If want to learn more about required minimum distributions, whether you are already taking them or you’re preparing to take them in the future, please reach out to us!
Any opinions are those of Kathryn Beach and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notices.