Required minimum distributions have received a lot of attention over the past couple of years and you may be wondering what all the fuss is about. There are a lot of questions to ask yourself: Do I begin at 70 ½ or 72? How is it calculated? Why do I have to pay the dreaded taxes? Why am I forced to withdraw my funds?
But we want you to know that RMDs are not particularly all that bad! You have some choices, but as always – Uncle Sam just needs his cut.
Read on for an overview of when you must begin withdrawing, how much and some options you have for making the most of your RMD.
What is an RMD and how does it apply to you?
At age 72 the IRS requires you to start withdrawing, each year, from any tax-deferred retirement accounts you may have. This includes traditional IRAs, 401(k)s, and other company retirement accounts. If you are still working, RMDs from a 401(k) may be delayed until retirement.
The SECURE Act of 2019 pushed the RMD begin age back from 70 ½ to age 72. For anyone who turned 70 ½ in 2020 or later, your first RMD may be taken in the year you turn 72 or by April 1st of the year after you turn 72.
However, by delaying your first RMD into the following year, you are then required to take that RMD as well as the current year RMD, thereby increasing your taxes. Distributions are taxed as ordinary income and you may choose to have federal and state (if required) taxes withheld automatically.
It is crucial to educate yourself on these rules as the penalties are brutal; a 50% penalty tax of any shortfall will go to Uncle Sam! Roth IRAs do not require withdrawals during the account owner’s lifetime.
Calculating your RMD
To calculate your RMD, divide the previous year’s year-end balance by the IRS life-expectancy factor based on your age at the current year end. You may find useful information at www.irs.gov regarding the life expectancy factor tables.
New this year, the factors were adjusted to slightly decrease the amount that is required to be distributed. This was done because retirees, on average, are living longer. If you have more than one retirement account, you may aggregate the total RMDs (calculated separately) and take it all from one account or a portion from each account.
You may take this total over the course of the year, or lump sum as long as it’s done by December 31st each year. Some prefer monthly distributions because the cash flow is needed while others might take it at the beginning of the year just to ensure the task is complete.
How to utilize your RMD
Although distributions are required to come out of your retirement account, they are not required to be spent. If you do not need these funds to help with your current cash flow (insurance, taxes or other living expenses), you may determine other uses for these funds:
- Reinvest – If you wish for these funds to continue to grow and/or wish to leave some for your heirs, you may reinvest the funds in a taxable brokerage account. Any gains will then be taxed at your capital gains rate upon the sale of the investment.
- Donate/Qualified Charitable Distributions (QCD) – If you are charitably inclined and would like to avoid Uncle Sam, QCDs may be an attractive option for you! A QCD is a direct transfer from your traditional IRA to one or more qualified charities (charity must be a 501(c)(3) organization). These distributions come out of your IRA tax free, can satisfy all or some of your RMD, and are limited to $100,000 per person annually. QCDs can lower your adjusted gross income allowing you to potentially stay in a lower tax bracket and reduce or eliminate the taxation of other income such as Social Security as well as keep your Medicare premiums at a minimum. Did you know that you don’t have to wait until RMD age to begin QCDs? You are eligible to start at age 70 ½.
- Increase Savings – If you don’t already have an emergency fund set aside for large, unexpected expenses this would be highly recommended. How much should you save? The typical rule of thumb is 3-6 months’ worth of expenses.
- Pay Down/Off Debt – Whether large or small, paying down debt helps us to sleep better at night. Focus on paying debt with the highest interest rate first. You may also consider paying extra on any mortgage or other loan.
- Pay Taxes – You can use your IRA to make a tax payment. For example, you may ask your custodian (or financial advisor) to process a distribution and withhold up to 100% in taxes.
- Take a Trip – Already have your living expenses under control, investment accounts well established and a well-funded emergency fund? Check off a trip on your bucket list and make some memories with family and/or friends!
While some folks are not fond of being “required” to withdraw funds from their hard-earned retirement savings, there are options to have these funds continue to work for you. Whatever your desires are for these funds, it is always best to talk through your options with your Financial Advisor and CPA/Accountant.
If you have questions about your retirement planning, RMDs, and alternative investment options, please give Tull Financial Group a call on 757.436.1122. We’d be happy to talk to you about how to make the most of all your income and investments.
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