2020 was the year when required minimum distributions (RMDs) were not required from IRAs and qualified retirement plans. Given the economic uncertainty of the economy and the volatility of the financial markets, Congress wanted to give everyone maximum flexibility in managing their assets.

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That reprieve is now over, so RMDs are back. If you were of an age to be taking RMDs before the pandemic, you must now resume doing so. The trigger age for RMDs is now 72.

Determining your RMD changes every year, but is not impossible to understand on one’s own. The formula is the same every year, though the IRA actuarial tables mean the amount will change from year to year based on your age. To determine the amount:

One adds together the value of all traditional IRAs and interests in employer retirement plans at the close of the prior year, then divides that total by an actuarial factor given in an IRS table. In the first required year, at age 72, the actuarial factor is 25.6. Thus, someone at age 72 who has $100,000 in total plan assets would divide that total by 25.6 and find that they have a first RMD of $3,906.25, or about 3.9% of the accounts.

Accuracy in calculating and receiving the RMD is very important, as a 50% penalty tax applies to amounts that should have been distributed but weren’t.

That sounds like a tedious exercise each year, but it’s doable. Actually, when you get into it the RMD decisions have additional complex facets to consider beyond just what the amount is going to be. Factors such as:

When should you take the money?

If you will be using the RMD money to meet expenses of daily living, you may want to consider taking the money on a monthly basis, a kind of do-it-yourself pension plan. That way the funds fit into your regular retirement budget. Should you run short, you can always take an additional withdrawal at any time.

Some people prefer the certainty of “getting it over with” and taking the entire RMD early in the year. Others argue for waiting until December for maximum tax-deferred buildup of the money. For example, in the first year if the funds enjoy a total return of 8% during the year, the RMD would be satisfied with half of the return, and the accounts would continue to grow.

Note that in the first year of RMDs, the first RMD does not have to be paid until April 1 of the following year.  Otherwise, RMDs must made by December 31 each year.

Multiple account issues

If you have several accounts from which RMDs will be required, you need not take an RMD from each one. You can actually take it in any other proportion you choose, provided only that the total dollar distribution equals the RMD. However, if the entire RMD is taken from just one account it may have unexpected implications.

Example. Jim has an IRA rollover worth $200,000 from his first employer, a 401(k) worth $250,000 from his most recent employer, and a traditional IRA worth $50,000. When he turns 72 his first RMD will be $19,531.25. He might opt to withdraw the entire amount from any one of these accounts. When he does so he may face:

Unexpected change of asset allocation – Now assume that IRA rollover is invested in bonds, while the other two accounts hold stocks or equity mutual funds. Should Jim take the entire RMD from the IRA rollover, he will be changing his asset allocation, increasing his exposure to stocks. Is that the right decision? One needs to know more about Jim’s entire financial picture to answer that question, but the election should not be made thoughtlessly.

Unexpected change of beneficiary distribution – Now let’s assume that Jim’s spouse is the beneficiary of the IRA rollover and the 401(k), but his kids are the beneficiaries of the traditional IRA. Should Jim choose to take the entire RMD from the traditional IRA, he will be altering his estate planning, disinheriting the children to some extent. Again, that might be the right thing to do, but the ripple effects of selecting the source of the RMD must be taken into account.

Balancing other income sources

RMDs are subject to ordinary income tax, and that means they have the potential to push the owner into a higher tax bracket. If that happens, the RMD can have the effect of making more Social Security benefits subject to income tax, and they may even cause an increase in Medicare premiums.

For the tax sensitive philanthropists that don’t need the RMD money to live on, there is a strategy called the “charitable IRA rollover.” The full amount of the RMD, up to $100,000, may be transferred directly to a qualified charity. When this is done, the RMD is not added to taxable income and no additional tax consequences are created.

Not for amateurs

These choices become even more bewildering for married couples who both own retirement assets. Meeting with a client advisor, such as those at Arvest Wealth Management, can be an invaluable resource to any retiree who has the good fortune to own substantial assets in qualified retirement plans.

 

This content has been provided by Merrill Anderson and is intended to serve as a general guideline.

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