The tax deferral accorded to IRAs and qualified retirement plans has helped to push total retirement resources in the USA to $33.6 trillion at the end of 2022 (Investment Company Institute 2023 Fact Book). Eventually, tax deferral must come to an end. The mechanism for facing the tax music is the Required Minimum Distribution (RMD). The IRS has published a table of actuarial factors applicable to each year of retirement. To determine an RMD, the value of the account at the beginning of the year is divided by the factor for one’s age.
Example 1: Peter is 75 years old, and his IRA is worth $250,000 at the beginning of the year. The factor for that age is 24.6. Therefore, Peter’s RMD is $250,000/24.6, or $10,162.60.
Multiple accounts – If a taxpayer has more than one tax-deferred retirement account, their values must be combined to calculate the RMD. However, there is no requirement to take a distribution from each account. The RMD may be taken in whatever proportions suit the retiree’s investment plan.
Example 2: Paul, also 75, has an IRA worth $200,000 invested in equity mutual funds, and he has a 401(k) plan balance of $400,000, split between stock and bond funds. Paul’s RMD is $24,390.24 ($600,000/24.6). To reduce his exposure to stock market volatility, Paul may decide to take the entire RMD from his IRA.
Congress has tinkered with the starting age for RMDs in recent years. The original age of 70½ was lifted to age 72 in the SECURE Act in 2019, dropping the half-year convention that caused taxpayer confusion. Then, last year, SECURE 2.0 raised the age to 73, as of 2023, and promised an additional boost to age 75 in ten years. The table below summarizes the new rule:
Beginning ages for Required Minimum Distributions
|Age for RMDs to begin
|1950 and earlier
|1951 – 1959
|1960 and later
Source: Internal Revenue Code
Because of this change, no one will have to begin their RMDs in 2023. Those who turned 72 in 2022 were required to have an RMD for that tax year, which they must have received no later than April 1, 2023. Those who turn 72 in 2023 won’t have an RMD until 2024. A grace period allows the first RMD to be delayed to April 1, 2025, but in that event there must be two RMDs in that tax year.
Reduced penalties. The prior law’s rule was that failure to take an RMD resulted in a penalty tax of 50% of the amount that should have been distributed. Thanks to SECURE 2.0, effective in 2023, the penalty tax is reduced to 25%. Additionally, if the taxpayer corrects the error by taking the RMD the following year, then the penalty is further reduced to 10%.
A different rule for inherited IRAs
The SECURE Act also changed the RMD rules for inherited IRAs, and they are considerably more complicated. The general rule is that an inherited IRA must be distributed over ten years, regardless of the age of the heir. Under this rule, the heir has the option to leave all the money in the IRA until the tenth year, for maximum tax deferral, or may withdraw as much or as little as desired during the first nine years. Exceptions apply.
At least as fast. If the deceased IRA owner was receiving RMDs, the heir must continue on that RMD schedule for the first nine years. Then, they withdraw the remainder in the last year. Larger earlier distributions are permitted.
Children. The ten-year rule does not apply to children of the account owner until they reach age 21. This exception does not apply to nieces, nephews or other relatives who are minors.
Surviving spouses. A surviving spouse may take the RMDs over his or her lifetime and the ten-year rule does not apply. Alternatively, the survivor may treat the inherited IRA as his or her own, which means RMDs can be avoided completely until the required beginning date is reached (73 or 75, depending upon the birth year).
Individuals who have a disability, are chronically ill, or beneficiaries who are less than ten years younger than the account owner are also permitted to take RMDs over their lifetimes.
Avoiding the RMD
Two strategies should be considered for managing RMDs.
Qualified Charitable Distributions (QCDs): Taxpayers who are 70 ½ and older may direct a transfer of up to $100,000 per year from an IRA to a qualified charity. The distribution will not be included in taxable income, but it will qualify as an RMD for older retirees.
Conversion to a Roth IRA: Roth IRAs are not subject to the Required Minimum Distribution rules (but note that inherited Roth IRAs are so subject). The conversion to a Roth IRA is subject to income tax, which can mean a big tax bill if done all at once. A better plan may be to convert an IRA to a Roth IRA over a period of years.
Managing Retirement Funds
Retirement lasts a long time, and knowing what the RMDs are for each year is just one of many factors that need to be considered when managing retirement assets. There are things we control, such as the retirement start date and, to some degree, how much we spend. There are other things we can’t control, such as the economic environment that will exist at retirement. That’s where it can be helpful to have a financial co-pilot who helps people through their retirements on a daily basis. A client advisor at Arvest Wealth Management can talk through your retirement income concerns, help project expenses and, after a full overview, revisit your plan annually to let you know what your RMD should be for that year.
Reach out to us for a consultation.
This content has been prepared by The Merrill Anderson Company and is intended as a general guideline.
© 2023 M.A. Co. All rights reserved.
Arvest and its associates do not provide tax or legal advice. The information presented here is not intended as, and should not be considered, tax or legal advice. Consult your tax and legal advisors accordingly.