Many of our readers are planning to retire, and they want to know about required minimum distributions (RMDs). If you have a tax-deferred vehicle, RMDs are something that you should learn more about.

Tax-deferred vehicles are:

401(k)
403(b)
457
IRAs (traditional)

When you’ve deferred taxes, you’re making an agreement with the IRS that you’re not going to pay taxes on this money now. But in the future, when you’re able to access the funds, the IRS will come knocking on your door because they want their cut of the money.

Under today’s requirements, you must start taking your required minimum distributions at age 72 – it was 70 and a half not too long ago.

RMDs are not a bad thing, and these are retirement accounts that you’ve been paying into for 30 or 40 years. However, since you’ll have to pay taxes on the distributions, some people get concerned.

Don’t be. This is money you saved and will be using for your retirement.

Understanding When You Must Take RMDs

RMDs are part of your retirement planning, and while you start taking them at age 72, this definition is a bit misleading. According to the IRS, you must begin taking distributions in the year you turn 72.

If you don’t turn 72 until December 31, guess what? You can take distributions from January 1^st (you’re still 71) since it’s in the year that you turn 72, or you can wait until December. So, you can strategize to some degree on when is best for you to take your RMDs.

You must take the distribution by the calendar year end (with one exception listed below).

How RMDs are Calculated

The IRS will try and estimate your life expectancy, based on several factors, and then calculate your RMD. The required distribution can vary from year to year, so the RMD isn’t a fixed rate.

For example, let’s say that you have $500,000 in all of your IRA accounts.

If you have this much in your account on December 31^st of the previous year, you would divide this amount by a factor that the IRS has created. The factor, at the time of writing this, is 25.6 for someone that is age 72.

The IRS figures that at age 72, you still have 25.6 years left to live. Your health isn’t personally calculated as these factors are across the board for everyone. So, you’ll be required to take the following RMD:

$19,531.25 ($500,000 / 25.6)

You can take a larger distribution if you want. However, you must take the minimum amount and it’s added to your income for the year.

In your first year, you can defer the distribution until April. You may want to defer the distribution to avoid taxes, but you’ll still need to take the distribution the second year.

In fact, if you defer the first distribution, you’ll be required to take the first and second distribution in the second year, adding significantly to your yearly income.

What to Do If You Have Multiple Tax-deferred Accounts

If you have 5 different tax-deferred accounts that require RMDs, you can take money from one or all of them. The IRS doesn’t care which accounts the distribution comes from. However, they do care that you’re taking the RMD (based on the combined value of all accounts) and paying tax on it.

What Happens If You Miss an RMD?

You’re penalized. You can be penalized by as much as 50% for missing your RMD.

3 RMD Strategies If You Need to Take RMDs in the Near Future

For anyone that is not retired yet but will be in the near future and has these tax-deferred accounts, there are a few strategies that can help you:

1. Roth Conversions

If you have an RMD, you cannot convert it into a Roth account. However, what you can do is a Roth conversion before you hit age 72. If you convert today, there are no RMDs, but you do pay taxes today.

You’re still paying taxes, but you know today’s taxes and not what your tax burden may be in 10 years.

When you use this strategy, you’re controlling your tax burden because you decide to convert the account at a time of your choosing and at a favorable tax bracket. For example, if your Roth account grows at 7.2% per year, you’ll double your money in 10 years and won’t have to pay taxes on your RMDs.

Of course, this doesn’t make sense for everyone.

We run simulations to see if this is a good strategy for our clients.

2. RMDs are Required, But You Don’t Have to Spend the Money

Many times, we’ll advise people to take money out of the IRA and then put it in another investment account. You don’t have to spend the money that you take out of your account, but you do need to pay your taxes on it.

3. Qualified Charitable Distribution

We have many people who don’t need the entirety of their RMD, so they’ll leverage what is known as a qualified charitable distribution, or QCD for short. A QCD allows those who want to donate to charity to do so with tax benefits.

Let’s assume that you have a $20,000 RMD and want to donate $5,000, you can.

When you do this, you’ll pay taxes on $15,000 instead of $20,000. You will need to go through your IRA to make this distribution, but you need to ensure that the distribution is in the charity’s name, address, and Tax ID.

You want the custodian to do the transfer for you so that the money never enters your account.

If you’re planning on giving to charity any way, the option of making a qualified charitable distribution makes a lot of sense for anyone that has an RMD that they must take.

The earlier you plan to reduce your RMD tax burden, the better. But, even if you plan on using our last strategy to lower your taxes, you want to start as early as possible to make sure it gets done in time for tax season.

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Changes made in 2019 have affected a lot of people’s retirement accounts and how they work for their beneficiaries. It’s important for anyone with an IRA to know how the Secure Act and Cares Act affect their IRA because the changes are both good and bad.

The SECURE Act and Your IRA

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20, 2019. Changes under the SECURE Act have both good and bad points, which have many people confused. These changes include:

Repeal on Age Restriction for Contributions

Before the ACT passed, you couldn’t contribute to your traditional IRA after you reached 70 ½. Now, you can continue making contributions after this age, which is beneficial for people that continue working after they reach 70 ½ age.

You will need to have eligible compensation to be able to make these contributions.

New 10% Early Distribution Penalty Exception

Exceptions are now given for adoption expenses along with the birth of a child. If you take distributions before 59 ½, any portion of the distribution that is taxable is subject to a 10% additional tax.

This is a steep penalty, and since most people don’t realize that they’ll suffer a 10% penalty until they do their taxes at the end of the year.

Under the new rules, there is a $5,000 exemption per participant if you want to take money out for qualified adoption or birth expenses. The changes are beneficial for anyone that plans to adopt or have a child and needs to find some way to pay for these expenses.

Death of the Stretch IRA

People save in retirement accounts because of tax deferment. You can allow compound interest to work for your retirement account and grow your money more without paying taxes now.

If you die, your beneficiaries can also leverage this same deferment to a certain extent.

Prior to the SECURE Act

A designated beneficiary could stretch distributions for your life expectancy. For a beneficiary, this was highly desirable because assets would remain in the account and grow year-over-year and only have to pay beneficiary required minimum distributions.

The practice was a great way to build wealth.

With a Roth IRA, the distributions became tax free with a qualified event, such as the death of the owner. For many beneficiaries, this was one of the most devastating changes under the SECURE Act.

The SECURE Act changed it so that the stretch IRAs now requires beneficiaries to drain the account in the first 10 years after the account owner’s death. The rule is in place for most non-spouse beneficiaries.

Distributions are optional from year 1 – 9, but if you don’t drain the account, you must increase it by the end of year 10.

A few exceptions are if the beneficiaries are:

Disabled
Chronically ill
Minor child
Spouse of the deceased

Even with a minor child, once the child hits the age of majority, the account is switched to the new 10-year period.

A lot of articles seem to miss on exception, which is if the beneficiary is no more than 10 years younger than the account owner. You’ll be able to take a distribution of the account over your lifetime.

What does this mean for you?

The stretch is available for older beneficiaries, which is a nice perk that is offered to eligible for certain beneficiaries. For any beneficiaries that are listed above, the stretch exists otherwise the SECURE Act does remove the stretch IRA.

Qualified Charitable Distributions (QCD) and Why You May Want to Make Them

QCDs shouldn’t be tied into your required minimum distributions. You can begin QCDs as long as you’re 70 ½ at the age of distribution. The Cares Act allows you to make a QCD without needing to take a required distribution.

A lot of financial managers are excited with changes to the QCD because, under the old rules, if you took a distribution from your retirement account, any pre-taxed amount is included in your income.

The exception is if you make a QCD to an eligible charity.

It’s vital that the charity be eligible because if the distribution is made to the charity, the distribution will be tax-free. You can do this up to $100,000 per person each year. Churches are included in this tax-free distribution treatment.

Note: Under the SECURE Act, you don’t have to start taking out your required minimum distribution (RMD) until you’re 72.

CARES Act and Its Importance to Your IRA, 401(k), etc.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act also has some important changes for your retirement accounts. Under the CARES Act, the RMDs aren’t required for 2020.

Under the CARES Act, if you lost your employment or income, you can take up to $100,000 in distributions from your account in 2020. You won’t need to claim 100% of the distribution on your taxes, but you can spread it across three years instead.

You’ll also not have to take a penalty due to the coronavirus-related distribution.

Qualifying for the distribution requires you to be a qualified individual, which falls into the following categories:

Test positive for COVID-19 (you, household member, etc.), or
Have your income, or a household member negatively impacted due to the coronavirus

If you took someone into your home this year, you could take this benefit if the person is experiencing hardship because of the pandemic.

The IRS hasn’t mentioned how they will verify that your claims are true.

The CARES Act isn’t subject to that 10% early distribution penalty mentioned earlier.

Note: Many 401(k) plans don’t allow this distribution. You may be able to treat the distribution as a coronavirus distribution.

RMDs and 2021 Possibilities

A lot of advisers were uncertain of what changes may occur in 2021 as the pandemic lingered and even surged to start 2021. There was lot of speculation that there may be some RMD benefits, but this doesn’t seem to be the case as of April 2021.

It seems that those 72 or older will have to resume their RMDs in 2021, with a few changes to keep in mind:

You can postpone your 2021 RMD to April 1, 2022, but you will need to take two RMDs and risk having to pay higher taxes if the distribution puts you into a new tax bracket.
It’s expected that new legislation will take place in 2021, so you may want to hold off on your RMD because it’s possible that they could be affected.
Life expectancy tables have been updated by the IRS and will affect your RMD. The changes will reduce a 72’s first RMD by 6.57% under the change.

Congress has also signaled some interest in pushing the starting age for an RMD up to 75 years old, but it remains to be seen whether this type of legislation will be approved.

If you’re turning 72 this year, you will have to take your first RMD by April 1, 2022.

Overall, the SECURE and CARES Acts have changed IRA RMDs and have some tax advantages. If you’re confused about the changes, speaking to an adviser can add some clarity and help you make the most out of your retirement accounts.

If you want more information about preparing your finances for the future or retirement, check out our complimentary Master Class, ‘3 Steps to Secure Your Retirement’.

In this class, we teach you the steps you need to take to secure your dream retirement. Get the complimentary Master Class here.

IRAs – Required Minimum Distributions