March 16, 2021 — If you turned 72 in 2020 or before, you probably will have to take a Required Minimum Distribution (RMD) this year from your IRA and/or 401(k) type plans. That is unlike last year, when COVID relief in the SECURE Act gave everyone a pass on taking the RMD.
All of those years when you were deducting your 401(k) and IRA contributions from your pre-tax income, and enjoyed tax free accumulation of earnings and interest on those investments, come home to roost when you reach a certain age. The law requires that you take an RMD from those retirement funds by a percentage that grows every year. Every cent of those withdrawals is considered taxable as ordinary income. Inherited IRAs and 401(k)s have different rules. Roth IRAs generally do not require RMDs.
The age at which you must start taking your first RMD has changed. If you turned 70 ½ in 2019 or earlier, you need to have taken your first RMD by April 1 of the year after that, and keep making them for the rest of your life. If your 70th birthday is July 1, 2019 or later, you do not have to take withdrawals until you reach age 72 (first one by April 1 of the following year and Dec. 31 thereafter). The idea for pushing out the requirement by 1½ years is to help retirees accumulate more savings before they have to start withdrawing them. Note if you delay the first one until April 1 the next one has to be paid by December 31. There is currently a bipartisan bill in congress that would extend the age when you have to take your first distribution to 75.
Examples from the IRS, and a nice break from some
The witching day is for birthdays on July 1, 1949. As you can see in Example 2 below, the new rules give a nice break to someone born that day vs. the day before.
Example 1: You are retired and your 70th birthday was June 30, 2018. You reached age 70½ on December 30, 2018. You must take your first RMD (for 2018) by April 1, 2019. You will take subsequent RMDs on December 31st annually thereafter, as will be discussed below.
Example 2: You are retired and your 70th birthday was July 1, 2019. You reach age 70½ after December 31, 2019, so you are not required to take a minimum distribution until you reach 72. You reached age 72 on July 1, 2021. You must take your first RMD (for 2021) by April 1, 2022, with subsequent RMDs on December 31st annually thereafter.
How much will my RMD be
The required distribution percentage starts at 3.91% of your plan assets at age 72. Every year you live past that the percentage goes up, reaching 15.87% at age 100. Here is a link to Vanguard’s RMD Calculator. Another way to calculate the RMD is to use the IRS Life Expectancy Factor and divide your taxable retirement assets by that factor. At age 70 the Factor is 27.4.
How do I calculate my RMD
You must calculate your RMD on all of your retirement accounts (except Roth IRAs), but you can withdraw it all from one account if you prefer. 401(k)s and IRAs (and others like them) have to be calculated separately and cannot be combined. Vanguard, Fidelity, etc. will tell you how much you have to take out each year. You can set it up so that the distributions are automatic each year. Or you can do it the hard way by using the IRS Worksheet. Amounts in your Roth IRAs are not subject to RMDs.
The penalties for non-compliance are hefty. According to the IRS, if an account owner fails to withdraw the RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.
Tax advantages made these programs work
IRAs and 401(k)s have turned out to be a great way to encourage retirement saving. Their tax advantages were appealing and easy to see: the contributions to the plans were tax deductible at the time they were made, and all earnings and capital gains have been tax free all this time. But the intent behind the plans was not to let us enjoy these tax advantages forever. RMDs require that the money in the plans comes out eventually, and all of it is is taxable.
Don’t pay taxes – make a Charitable Deduction instead
RMDs are considered ordinary income so you must pay taxes on them. But, you don’t have to pay taxes on your distributions, if you give them to a qualified charity as a qualified charitable distribution (QCD). For many people this is a great strategy because they probably would donate to a charity anyway. It is also helpful for those who take the standard deduction and can’t use charitable donations. So instead of donating money from your non-retirement funds and then claiming a deduction, you give from your 401(k) or IRA and don’t have to count the money as income. Important: The donation must be made directly from the financial institution to the charity. The amount of the distribution you donate (you can give all of part of your RMD) will not count as income for your taxes. The RMD charitable tax break was made permanent in 2015. If interested in this strategy, consult with the firm that holds your retirement funds – well before the end of the year!
There are some exceptions which allow some people who have not yet retired to delay their first RMD. See RMD FAQs at the IRS, or your tax professional. People who own more than 5% of their company have a different set of rules.
Comments? Have you had any problems calculating your required distributions, or other issues? Please share your thoughts in the Comments section below.
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