72 and Worried About Your Upcoming RMD – Learn the Facts

Updated: 4/2/2024

There’s many issues that come to the fore in retirement, with RMDs among the most misunderstood and feared by seniors. That doesn’t have to be the case.

Introduction                                                                                                              

No doubt the acronym IRS drives fear into even the most rule abiding, never “walk on the wrong side of the street” individuals in the U.S.

Even they automatically recoil at those three letters. That’s despite the fact they know they’ve never done anything wrong or should fear the IRS, let alone deserve attention or scrutiny from the agency.

It’s just normal.

Yes, we all tell ourselves it’s just normal to get nervous. And to chill out. Followed by the brave proclamation, “I’ve got absolutely nothing to worry about with the IRS.”

But get a correspondence with those letters on it and your stress level automatically shoots through the roof. You start to question that previous decision regarding an expense or that deduction claimed on your tax filing from last year…or even 10 years ago.

Suddenly you envision yourself walking the “yard,” sporting leg irons during your daily 30-minute break outside your cell.

Not fun or pleasant. And certainly something we can all understand…none of us wish to ever get up close and personal with the agency or its personnel.

Given all that, it’s no surprise that as we age up and start to deal with retirement and the rest of our lives, there is another acronym that starts to put fear in us.

Yes, the dreaded IRS-mandated Required Minimum Distribution, or RMD.

Fact is RMD emanates from the same agency (IRS) and deals with the same issue – paying to Ceasar what is Ceasar’s.

And with the turn of the calendar you reach a certain age – that time when you must begin to pay the tax-man his due. It can be scary.

But it doesn’t have to be overly scary or confusing. Learning the facts can help take much of the anxiety out of RMDs. Today we are going to look at the basics to help defang dealing with RMDs in your retirement. It may not alleviate all your worries, but knowledge can make them easier to deal with.

Recap

Best place to start is with a quick recap on exactly what an RMD is so there is no uncertainty.

When we start to save for retirement, hopefully while still pretty young, we enter into a partnership agreement with the IRS.

It allows us to hold on to some of our income that would normally go to the gov’t each given year in which we collected a paycheck.

Now that you’re older do you feel like you were hoodwinked or wish you had read the fine print? You’re not alone…

There’s actually some good benefits in the deal. First, we reduce some of our taxable income each year (up to limits), which equates to keeping more of what we earned. And we get to utilize tax-advantaged qualified accounts, such as those you are probably familiar with – IRAs, 401(K)s and other employer-sponsored plans.

Then there is the biggie. All that money you socked away grows with the benefit of compounded interest, accumulating year after year. This starts to really add up and do its magic over time. Your money is able to do so without paying taxes, so you have more accumulated in your retirement accounts than you would have had, which is a powerful benefit.

But there is a catch…as there always is.

The optimal phrases just mentioned were tax-advantaged and qualified accounts. The IRS always wants to see the other end of the promise kept.

They want what is due to them in the taxes that went deferred, as well as the dollars earned (gains) on that money over time.

A major manner in which they enforce that agreement with you is through a mechanism that forces you to begin taking taxable distributions when you reach a certain age in retirement. They get their pound of flesh, as it were, capturing taxes paid at an “ordinary income rate” with each required distribution – the RMD.

Which money?

Now that we’ve covered the baseline facts regarding RMDs, let’s move on to what is covered by your agreement with the IRS.

Short and sweet, the pre-tax dollars you were able to contribute into qualified accounts is what we are talking about. This includes both the tax-deferred contributions as well as the interest earned on those dollars.

There might even be money that was legally contributed into your qualified accounts on an after-tax basis (taxes already paid when contributed) where you will owe on the gains generated by those dollars, but not on the principle amount, as those funds were already taxed.

There’s also another important area we will come back to in this regard – Roth IRAs.

Which accounts?

According to the IRS, the required minimum distribution rules apply to all employer sponsored retirement plans, including profit-sharing plans, 401(k) plans, 403(b) plans, and 457(b) plans.

RMD rules also apply to traditional IRAs and IRA-based plans, such as SEPs, SARSEPs, and SIMPLE IRAs.

Taxes

The taxes you will begin paying when you must start taking distributions – whether you have a need for the income or not (based on your assets, needs, goals, et. cetera) – will be predicated on your income and tax rate at that time, along with the IRS Uniform Lifetime Table. (Note- maybe a version of the ULT inserted here – see below)

For savings held in a single or multiple IRA accounts, the amount owed is based on your collective savings between them all – that’s whether you have one, two, three or more. Keep in mind you can take the distribution from just one account if you prefer, but it must cover the collective amount owed across all of your IRAs.

When it comes to employer-sponsored accounts, you must actually take a distribution from each individual plan, based on the savings in that account at year end.

Key timeline

So, when does all this mess start……

Drum roll……………… The age back in the day used to be 70 1/2. That extra half year was like the infamous “hanging chads” snafu we all dealt with in the 2000 Presidential Election count in the state of Florida. You can be sure the extra half year was confusing and annoying to everyone who had to deal with it in the past.

The introduction of the Setting Every Community Up for Retirement Enhancement Act, more commonly referred to as the Secure Act of 2019, removed the issue of the 1/2 year and actually increased the RMD age to 72.

Not done tinkering, Congress enacted the Secure Act 2.0 of 2022, which raised the RMD age to 73 for those who turned 72 in 2023 or thereafter. And recognizing the direction life expectancy is trending, they set it to increase to age 75 in 2033.

Scratching your head and still asking what that all means to you? Simply stated, you are generally (love the “generally,” yes, there are exceptions) required to begin your RMD withdrawals annually starting the year you reach age 72, unless you reach age 72 after Dec. 31, 2022.

Okay, so now we have that all clear.

So the next question is when must the distribution occur? Lolol

We did mention exceptions…

In the year you must start your RMDs you are responsible for doing so by year end (12/31), but the IRS allows you until April 1st of the following year to actually take the withdrawal.

But…big but… If you do elect to wait until April 1st of the year following, you will be responsible for two distributions in that year – April 1st for the previous year and by 12/31 for the current year.

Back to confused?

Actually it’s not that confusing. If you turn 73 in 2024, you will have to start your RMDs this year, with the first due by 12/31. But the IRS will allow you to delay taking the distribution until April 1, 2025 as long as this is your first RMD. And the distribution will still be reported as ordinary income for your 2024 taxes.

In 2025 you will have to take another distribution by 12/31 for the 2025 tax year, with taxes due when you file your taxes for that year in 2026.

After your very first RMD, all distributions must occur by 12/31 each year or they are considered late, which does come with penalties. More on that in a minute.

Clear as day…

Oh yeah, there is an exception if you are continuing to work when your RMD starts and you have an employer-sponsored plan, which more and more is occurring.

In that situation you can delay your first distribution from that plan until April 1 of the calendar year after you retire from employment with the employer administering the plan. Thereafter your RMD for that account will work as previously detailed.

Importantly, you have to remember that this applies only to the employer who administers that plan – if you were to quit and begin with another employer the exception is no longer in effect and you must begin your RMD for that plan per the age rule described above.

Also, you can’t own five-percent or more of the company with whom you have the plan.

Lastly, this doesn’t apply to any IRAs.

And yes, there are in fact other exceptions, such as for beneficiaries, if a spouse is 10 years younger than you, and more.

Penalties

We mentioned that the IRS is all about getting their pound of flesh and the fact they use the RMD to extract it when you reach a certain age.

Well, they wouldn’t be the IRS if they didn’t put some teeth into those things they require. That’s no different for RMDs.

In the past, were you to fail to take your annual RMD you would be penalized 50-percent on the amount you should have withdrawn, which would be due on top of the actual taxes that would have been owed.

According to the IRS, the Secure Act 2.0 now limits that penalty (technically an excise tax) to 25-percent of the amount not taken. And, if you correct the issue with the RMD within two years, it MAY be reduced to 10-percent by the agency. You have to contact the IRS in such an instance.

Roth and RMD

Hopefully you are familiar with Roth IRAs and benefits they can provide to you. There’s too much there to unpack here in this regard, but you can be certain there are rules and exceptions regarding Roth IRAs and RMDs.

First, Roth IRAs are not subject to RMDs during your lifetime as the owner of the account, which is one of the benefits of that type of account. But beneficiaries are subject to withdrawals and RMD rules after you pass.

Second, in the case of employer-sponsored designated Roth 401(K) and 403(b)s plans, according to the IRS, RMDs are still due for 2023. But starting with tax year 2024 you will no longer by subject to required minimum distributions on these types of accounts.

Whew!

Conclusion

Okay, we went a little tongue-in-check with the material for the sake of maintaining a wee bit of sanity. It can get dense and confusing. And for many they are scary.

Here’s an important truth though. If you find yourself coming up to the point where you’ll need to start RMDs, remember that if you expect to use savings from your qualified retirement accounts – whether IRAs, employer-sponsored, or a combination of both – then the fact is the dreaded RMD matters less because you will need some amount of that money anyways.

You may even take out larger withdrawals than required to cover your monthly/annual needs and to maintain your standard of living.

If instead you prefer not to use that money, there are strategies you can incorporate in advance of that date to help reduce or even mitigate RMDs. Roth conversations are one strategy that can help address the issue.

With RMDs and your taxes, and frankly many things involved with preparing for and living in retirement, there are myriad issues and situations where big decisions are necessary. They can get complicated and can come with serious repercussions that will affect the rest of your life.

That being the case, if you don’t already work with a qualified retirement planner you probably need to consider doing so for your own benefit. And you definitely need a good retirement plan.

Even if you already have a retirement plan (either your own or one created for you), our team would be happy to review it to determine if it is capable of really meeting your goals.

Or we can assist you by creating a retirement plan capable of helping you to retire with confidence. We can build a holistic, comprehensive retirement plan addressing relevant issues, utilizing strategies that cover RMDs, taxes, income, spending, healthcare, legacy, and more, customized to your family’s specific needs.

A plan created with the goal of ensuring you can successfully live out the retirement you envision.

If you are ready to take the next step and talk to a team of retirement planners who can advise on all your retirement needs, and who will put your interests first, Schedule a call today!