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Required Minimum Distributions: Just the Basics

11 minute read

When you reach a certain age, the IRS will require you to begin withdrawing from your 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 death, and then continue to grow tax-deferred until your 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 you don'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 you can do to optimize your 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:

Suppose you are retired and hold retirement funds in a prior employer’s 401(k) plan. You turn 72 on January 13, 2022. You will be required to take your first RMD on or before April 1, 2023.

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

If your plan allows for it, you may be able to push back your first RMD until after you retire.

EXAMPLE 2:

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

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

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How Are RMDs Calculated?

The RMD calculation is based on a combination of your 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 sole beneficiary is your spouse and your spouse is more than 10 years younger than them.

Table III Uniform Lifetime Table

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

You can calculate your RMD by dividing your 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 you reports a higher taxable income in years they take RMDs. However, there is one workaround for this. If you don't need retirement funds but are required to pull RMDs from your account, you should consider directing those funds to a charity instead.

What Are Qualified Charitable Distributions?

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

1. You can reduce their taxable income by the amount you donated, and

2. You 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 you 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 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 must resume taking RMDs.

Inherited IRAs are also subject to RMDs.

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

Spouse

If you inherit an IRA from your spouse, you will have the most flexibility. You can:

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

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

Non-Spouse

If you inherited a retirement account from someone who wasn’t your 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; you must report those withdrawals on your 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 you to delay them or reduce your tax burden.

To understand what treatment is right for you, determine what you financial needs are in retirement, if you plan to make charitable contributions with their wealth, and if you are the beneficiaries of anybody else’s retirement accounts. You can use this information to estimate your 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 decide what your best moves in retirement will be.

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