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Have You Taken Your 2021 RMD Yet: New Rules in Effect

Category: Financial and taxes in retirement

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.

50% Penalty
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!

Exceptions

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.

For further reading:

Kiplingers Article on RMDs with Many Good Suggestions

Posted by Admin on March 15th, 2021

8 Comments »

  1. RMDs must be calculated separately for 401k and traditional IRAs. You cannot combine them for the purpose of taking the distribution from one account. Also inherited IRAs must be treated separately. The same for 403b accounts.

    by LS — March 16, 2021

  2. Don’t you have to take 2 RMD’s the first year if you delay taking the first till the following year?

    by Billy — March 16, 2021

  3. Good points Billy and LS. We have edited the article to make these points clearer.

    Billy, you are right. That first year you have until April 1 for the previous year withdrawal but you still have to take the current year RMD by Dec. 31. So you can decide if you want to take one in the first year you are required to avoid two withdrawals in one year.

    LS, you are correct that you have to treat your 401k, etc. and IRAs separately. For that reason it is more convenient to keep all of them with one company and not have to go to several places to get the withdrawal amounts.

    by John Brady — March 16, 2021

  4. Admin, you skipped entirely inherited IRA’s. I inherited my Mother’s IRA when she passed away in 2013 and have to pay RMD on that account. I am not 72 and by the time I am, I will have paid 12 years on RMD’s before age 72. I was told it was mandatory to pay RMD’s on inherited IRA’s from time of inheritance. My Mother was 79 at time of passing.

    Editor Comment: You are so right Louise, good point about inherited IRA’s. They are a very different animal. And also complicated, depending if you are a spouse or other heir. This link at IRS has the basics. https://www.irs.gov/retirement-plans/required-minimum-distributions-for-ira-beneficiaries

    by Louise — March 17, 2021

  5. Richard Neal, D-Mass., and ranking member Kevin Brady, R-Texas, have introduced the Securing a Strong Retirement Act of 2020, which would change the required minimum distribution age from 72 to 75. It is uncertain if it will be passed, but since it is bipartisan it has a chance.

    by John Brady — March 18, 2021

  6. Louise brought up an Inherited IRA which may affect some but the rules have changed there for more recent non-spousal beneficiaries. I inherited part of an IRA last summer, when my father passed away. We have 10 years (until 31 Dec. of the 10th year or 31 Dec 2030 for us) to empty that account – all of it taxable income. Whatever is left in that Dec. they will write a check and close the account. Trouble with it now is that even though I have taken distributions, the total is still going up! Good news and bad news 🙂

    by HEF — March 18, 2021

  7. I think this article explains it better than the link Admin provided: https://www.forbes.com/sites/bobcarlson/2021/01/22/mistakes-ira-beneficiaries-are-making-after-the-secure-act/?sh=1a1b6ee869f0

    I was not aware of the Secure act till I read the article and how inherited IRA’s had to be withdrawn in 10 years time.

    I inherited my Mom’s IRA in 2013, therefore, I am grandfathered and continue the Stretch IRA for the rest of my life. I only take out the minimum required distribution each year and the original amount seems to keep building back up each year.

    by Louise — March 18, 2021

  8. Another consideration to keep in mind with RMDs, particularly if you have to take large ones, is state taxation. There are 9 states that have no income tax at all (AK,FL, NH, NV, SD, TN, TX, WA, WY,) and 3 other states do not tax distributions from 401(k)s and IRAs. Those are IL, MS, PA.

    by John Brady — March 22, 2021

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