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Required Minimum Distributions: Just the Basics

When your clients reach a certain age, the IRS will require them to begin withdrawing from their retirement accounts each year. This requirement is the IRS’s way of ensuring retirement funds are used during the account holder’s lifetime. Without this constraint, those funds could grow tax-deferred until your client’s death, and then continue to grow tax-deferred until their heirs draw from those funds. The IRS wants to tax those earnings now.These required withdrawals are called “required minimum distributions” – or RMDs. RMDs aren’t bad for every taxpayer, but if your client doesn’t need the money, the additional tax burden of the withdrawals can be a stressor. There aren’t many workarounds for RMDs, but there are still a few things your clients can do to optimize their tax positions in retirement.

Who is Subject to Required Minimum Distributions?

Retirement plan withdrawals are only mandated for certain taxpayers.Until recently, the RMD age was 70 ½, which meant that individuals were required to begin making withdrawals by April 1st of the calendar year following the year they turned 70 ½. However, when President Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act in late 2019, the RMD age rose to 72.  Today, taxpayers must begin taking RMDs by April 1st of the calendar year following the year they turn 72.

EXAMPLE 1:

Your client is retired and holds retirement funds in a prior employer’s 401(k) plan. They turn 72 on January 13, 2022. They will be required to take their first RMD on or before April 1, 2023.

If your client has an IRA, SEP, or SIMPLE IRA, they cannot push the RMD deadline back for any reason. But if your client has an employer-sponsored plan, like a 401(k) or 403(b), they may be able to.

If your client’s plan allows for it, they may be able to push back their first RMD until after they retire.

EXAMPLE 2:

Your client is currently employed and has an employer-sponsored 403(b). They turn 72 on November 13, 2021. They will not be required to take an RMD in 2022. They can wait until April 1st of the calendar year following the year they retire to take their first withdrawal.

But keep in mind, this delay could be a double-edged sword. Because your client is holding onto their funds for longer, their account balance will continue to grow and will be higher by the time they begin taking RMDs. This will make their required withdrawals even larger than if they had begun pulling from their accounts at age 72, which could be burdensome from a tax planning perspective.

How Are RMDs Calculated?

The RMD calculation is based on a combination of your client’s age, life expectancy, account balance, marital status, spouse’s age, and chosen beneficiaries. The IRS provides three tables to help you with the calculation.

Table I Single Life Expectancy Table

Use this table if you’re calculating RMDs for an inherited IRA (more on this later).

Table II Joint and Last Survivor Expectancy Table

Use this table if your client’s sole beneficiary is their spouse and their spouse is more than 10 years younger than them.

Table III   Uniform Lifetime Table

Use this table if (1) your client is unmarried, (2) your client’s sole beneficiary is their spouse and their spouse is not more than 10 years younger than them, or (3) your client’s spouse isn’t the sole beneficiary of their IRA.

You can calculate your client’s RMD by dividing their account balance at the end of the prior year by the relevant life expectancy factor published in the applicable table.

Are Required Minimum Distributions Taxable?

The short answer is: YES.

Most RMDs will be taxable, and that’s because most distributions from IRAs and defined contribution plans are taxable.

Withdrawals that might not be taxable are distributions that represent return of investment. Distributions from Roth IRAs, for example, are not typically taxable.

Because most RMDs are taxable, RMDs effectively ensure your client reports a higher taxable income in years they take RMDs. However, there is one workaround for this. If your client doesn’t need retirement funds but is required to pull RMDs from their account, they should consider directing those funds to a charity instead.

What Are Qualified Charitable Distributions?

Qualified charitable distributions (QCDs) are charitable contributions your client makes directly from their retirement account. By directing funds to go straight from their account to an IRS-approved charity, your client can do two things:

1. They can reduce their taxable income by the amount they donated, and

2. They can count those contributions as RMDs.

All taxpayers can make a QCD, regardless of income level, filing status, or whether they itemize or take the standard deduction. But QCDs are especially helpful if your clients are wealthy.

Many high-net worth individuals have multiple income streams in retirement and don’t need retirement funds to meet their lifestyle needs. If they don’t need their retirement funds, they can donate their RMDs to charity instead by initiating a QCD. This will reduce their taxable income and fulfill RMD requirements with one simple action.

How Do I Calculate RMDs for 2021?

When looking to calculate your client’s RMD for 2021, there are a few things you should think about:

RMDs were suspended in 2020, but they are required in 2021.

When Congress passed the CARES Act in March 2020, they suspended all RMDs for the 2020 tax year.

When the pandemic first hit, the market took a steep dive. Lawmakers hoped that the market would rebound quickly, and they didn’t want retirees to be forced to make withdrawals when their accounts were artificially (and temporarily) low. But this suspension was only for the 2020 tax year; in 2021, your clients must resume taking RMDs.

Inherited IRAs are also subject to RMDs.

If your client inherited a retirement account, they may be required to take withdrawals from their accounts even if they aren’t in retirement. The rules are different based on your client’s relationship to the former account holder.

Spouse

If your client inherits an IRA from their spouse, they will have the most flexibility. They can:

1. Become the IRA owner. They can either change the account to reflect them as the new owner, or they can roll those funds into their own IRA account. Either action would allow them to follow the regular RMD rules/calculations. If your client is not yet at RMD age but their spouse was, this can be an effective strategy to delay taking RMDs.

2. Remain the IRA beneficiary. Your client would only be required to take RMDs at the time their spouse was scheduled to turn 72. If your client’s spouse was already taking RMDs, your client must continue to take RMDs, but their RMDs could be calculated based off their own life expectancy rather than their spouse’s life expectancy.

Non-Spouse

If your client inherited a retirement account from someone who wasn’t their spouse, the rules are different. Because of a new clause added in the SECURE Act, all retirement funds inherited in or after 2020 from a non-spouse must be withdrawn within 10 years of the death of the IRA’s original owner.]  While these aren’t considered RMDs, they have the same effect; your client must report those withdrawals on their tax returns as taxable income.

RMDs Require Tax Planning

Tax planning in retirement is essential thanks in large part to RMDs. RMDs are unavoidable, but with some of the techniques listed above, there might be a way for your client to delay them or reduce their tax burden.

To understand what treatment is right for your client, ask them what their financial needs are in retirement, if they have plans to make charitable contributions with their wealth, and if they are the beneficiaries of anybody else’s retirement accounts. You can use this information to estimate their tax bills in retirement.Another great tax planning tool at your disposal should be tax planning software. Corvee’s tax planning software considers both RMDs and QCDs and can help you and your client decide what their best moves in retirement will be.

Demo 2021 Tax Planning Software

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