Retirement, Personal financeMarch 24, 2023
What to do when your retirement account tax holiday ends
When it comes to taxes, IRAs and 401(k) retirement accounts offer a pretty good deal. When you put some of your paycheck into those accounts, that money isn’t counted toward your taxable income.
And that’s not the only perk: your earnings on those accounts can grow without being reduced by taxes. You reduce your taxable income and increase your retirement savings while the Internal Revenue Service (IRS) sits idly by. What’s not to like?
But this great deal comes with an expiration date.
On December 20, 2019, the SECURE Act changed the RMD age for beginning required minimum distributions (RMDs) from 70 ½ to 72. On December 29, 2022, the Consolidated Appropriations Act of 2023 passed which included the retirement bill, SECURE 2.0 Act of 2022 (SECURE 2.0). The bill further pushed out the RMD ages. Beginning in 2023, for individuals attaining age 72 after Dec. 31 ,2022 the new RMD age is 73. The RMD age will begin even later at age 75 for those who attain age 74 after Dec. 31, 2032.1
The following chart shows the impact to individual RMD starting ages:
When you reach age 73, the IRS requires you to annually make a withdrawal from your tax-deferred retirement accounts. When you take money out of a retirement account, you must pay income taxes on the amount you withdraw. RMD rules define how much you must take out, and when you need to make your withdrawal.
The RMD world can be complicated by calculations, variations and exceptions. It’s taxes, right? No one ever said it was going to be simple. But you’ve dealt with taxes your whole life, so with a little effort you can definitely handle this.
Why do RMDs exist?
If you’ve been setting aside part of your earnings in an IRA or 401(k) or other tax-advantaged retirement account, you haven’t paid income tax on those dollars. The government lets you delay paying taxes, but RMDs are how the government ensures you’ll eventually be taxed.
Which retirement accounts are subject to RMD rules?
According to the IRS rules, if you have any of these plans, you’re required to take annual RMDs:2
- 401(k), 403(b) and 457(b)
- Traditional IRAs, SEP and SARSEP
- SIMPLE IRAs and Roth 401(k) accounts
Any investment or savings accounts you fund with money you’ve already paid taxes on are not subject to RMD rules, like Roth IRAs.2
Withdrawal rules differ for IRAs and 401(k)s. If you have more than one IRA, you can total your IRA RMDs and, if you wish, withdraw that amount from just one account. For 401(k)s, a separate RMD must be calculated for and withdrawn from each of your 401(k) accounts.3
When do I need to start taking an RMD?
You must start taking RMDs when you turn 73 or continue to take RMDs if reached the previous RMD age before 2023 (i.e. 70 ½ prior to January 1, 2020, or 72, prior to January 1, 2023.There is one exception: people still on the job after age 73 usually may delay taking RMDs from their employer sponsored plan until they retire.3You may want to check with the IRS or talk to a tax advisor for more details.
Your first required withdrawal doesn’t have to be made until April 1 of the year afteryou turn 73. After that first withdrawal, the IRS requires you to take RMDs by December 31 each year.
Here is an example
Betty turns 73 on Nov. 1, 2023. Betty has until April 1, 2024, to take her 2023 required minimum distribution. If she waits until then, she’ll also be required to take her 2024 distribution by December 31, 2024.
How much am I required to withdraw?
Your RMD is based on the value of your account on December 31 of the previous year.2An RMD for 2023, for example, is based on your account value as of December 31, 2022.
The withdrawal amount is calculated by dividing your account value by a number based on your age. In IRS terms, that’s called thelife expectancy factor — which can be found in the IRS’s Uniform Lifetime table,The IRS released new life expectancy tables for calculating RMDs for 2022.4Because the factor decreases as you age, the amount of your RMD will grow as you get older.
Here’s an example of how the life expectancy factor works:
- If your IRA balance at year-end is $1 million and you’re 73 years old, your life expectancy factor is 26.5 according to the IRS.
- Divide your balance by 26.5($1,000,000/26.5), and that equals $37,735.85, which is your RMD amount.
An 80-year-old with an identical balance would use the life expectancy factor of 20.2, which would result in a $49,504.95 RMD. For a 90-year-old, the RMD on the same balance would be $81,967.21.
Exception alert: If your spouse is the sole beneficiary of your retirement account and is 10 or more years younger than you, the life expectancy factor should be obtained from the IRS Joint Life Expectancy table.5
You can always withdraw more than the RMD amount, but any additional withdrawal won’t count toward future RMDs.
Is there a penalty if I don’t take an RMD?
SECURE 2.0 reduced the penalty for not taking an RMD from 50 percent of the amount that should have been withdrawn down to 25 percent.1,2The penalty is further reduced to 10 percent if corrected in a timely manner. If, for example, you did not take a required distribution of $10,000, your penalty would be $2,500 or $1,000 if corrected timely.1,2.
To get the penalty waived, you must convince the IRS that your failure to take a distribution was the result of a mistake, and you’ll need to show proof that you’re working to correct the error.
Can I invest my RMD in another retirement account?
The SECURE Act eliminated the maximum age limit for making an IRA contribution. IRS rules do not allow you to put your RMD into another tax-advantaged retirement account via a direct transfer. However, you can take your RMD, pay the tax and reinvest in an IRA if you have earned income for the year in which you make the contribution.
RMDs: A part of retirement that no one looks forward to, but help is available
There are many great things about retirement.
Unfortunately, RMDs typically aren’t one of them. The rules are complicated. The penalties are significant. And there’s math. But there’s good news — help is available!
Financial institutions that offer IRA or 401(k) accounts often notify their customers when an RMD is due. Many provide a calculation of how much needs to be withdrawn. If you’re approaching age 73, you may want to check with your IRA or 401(k) provider to find out what assistance they offer.
You also will want to look at the bigger picture and consider:
- How will RMDs affect your financial situation?
- How will your withdrawals affect your investment portfolio?
- Will the increased income from an RMD put you into another tax bracket?
- Could the additional income affect your Medicare premiums and the tax you pay on Social Security income?
It’s a good idea to discuss these questions with a financial professional, who can help you develop a strategy to prepare for RMDs. And your tax advisor can help you avoid unpleasant surprises at tax time.
With a little knowledge and some planning, you can get ahead of the game and be prepared when “RMD Day” comes.
