As retirement approaches, individuals must navigate a complex set of rules and regulations regarding their retirement accounts. One crucial aspect of retirement planning is understanding Required Minimum Distributions (RMDs). RMDs dictate the minimum amount individuals must withdraw from their accounts each year, starting at a certain age.

Overview

Required Minimum Distributions (RMDs) are the minimum amount of money individuals must withdraw from their Pre-Tax retirement accounts, such as Traditional Individual Retirement Accounts (Traditional IRA) and employer-sponsored retirement plans (401k, 403b, TSP), starting at a certain age. These distributions are mandated by the Internal Revenue Service (IRS), and failure to take RMDs can result in tax penalties.

Roth IRA and Roth employer plans (Roth 401k or Roth TSP) are after-tax retirement accounts.  So they do not have withdrawal requirements.

Changes in RMD Provisions: Secure Act 2.0 & Age Increase to 73

This new legislation introduced changes to the age at which individuals must start taking RMDs. Starting in 2023, the RMD age will increase from 72 to 73. This change gives individuals an extra year before they are required to take distributions, allowing them further flexibility in managing their retirement accounts.

You can learn more about the new law from our article here: SECURE 2.0 – Big Changes To Retirement Plans

Calculating the Required Minimum Distribution in 2023

Calculating the required amount is fairly straightforward. Most often, the institution your IRA is held with will assist you in calculating it.  However, if you want to do the math yourself or have moved your account during the year, you will need two pieces of information.   

To calculate the RMD, you need the account balance as of December 31 of the previous year.  Then, using the IRS life expectancy table, you can find the life expectancy factor.  The RMD is determined by dividing the amount by the factor. Here is an example.

A married person turned 73 in 2023.  On December 31, 2022 (the year prior to your RMD year), the account balance is $200,000. 

The RMD amount = $200,0000 / 26.5 (life expectancy factor at 73) = $7,547.17

Updates to the Life Expectancy Tables

In line with the new distribution rules, the IRS table for 2023 has been updated. You can find the which table to use and the life expectancy factor here:  https://www.irs.gov/publications/p590b#en_US_2022_publink100090055

Deadlines You Need to Follow

The tax penalty for missing an RMD is 25%! 

In order to avoid the penalty for missing a distribution, you typically need to complete the distribution by December 31 of the tax year.  However, if it is your first RMD, you have a one-time grace period to complete the first distribution by April 1 of the following year. 

For example:

A retiree turned 73 in 2023. You wait to withdraw your first distribution from your pre-tax accounts (IRA, 401k, 403b and etc) by April 1 of 2024.  However, remember that you still need to take the 2024 RMD by December 31, 2024. 

Strategies for Withdrawing an RMD

When it comes to withdrawing an RMD, there are several strategies that individuals can employ to optimize their withdrawals. One strategy is to carefully consider the timing of your withdrawals. Should you spread out the distribution over the year or take it as a lump sum?

Second, when it comes to your first distribution, should you take it at 73 or wait to take two in the year your turn 74? That all depends on your expected income for the year or tax bracket changes. This will be especially important when the federal tax rate changes between 2025 and 2026.

Another strategy is to consider the impact of your RMDs on your overall investment portfolio. By evaluating your asset allocation and adjusting it as necessary, you can align your portfolio with your retirement goals and risk tolerance. This approach ensures that your RMDs complement your investment strategy and support your long-term financial objectives.

Maximizing Your Retirement Savings with RMDs

While RMDs are mandatory, there are ways to maximize your savings within the framework of these distributions. One approach is reinvesting your RMDs into an after-tax investment account. By leveraging these accounts, you can continue to grow your investments.

Additionally, individuals can explore the option of a Qualified Charitable Distribution (QCD) to maximize their gifting while avoiding taxes. With a QCD, you can directly transfer your RMD amount to a qualifying charitable organization. This strategy not only satisfies your RMD requirement but also allows you to support a cause or organization you care about. You avoid paying the income tax on the distribution and the charity does not pay taxes.  The key is to make sure that it is a qualified charity. 

Tips for Compliance with RMD Rules

Compliance is vital to avoid tax penalties and ensure the longevity of your retirement. Here are some tips to help you stay on track:

1. Stay informed: Keep yourself updated on the latest regulations to avoid missing any important deadlines or changes.
2. Utilize technology: Take advantage of tools such as the Required Minimum Distribution Calculator to calculate your RMD amount and manage your distributions accurately.
3. Plan ahead: Develop a comprehensive retirement income plan that considers your RMDs, Social Security benefits, and other sources of retirement income to ensure a stable and comfortable retirement.
4. Seek professional advice: Consult with a financial advisor or tax professional who specializes in retirement planning to ensure you are making informed decisions and maximizing the benefits of your RMDs.