Whether you’ve just started saving for retirement or have been saving for decades, there are a few key concepts that you’re going to need to understand. Your financial advisor or tax advisor can help you with many of these retirement planning concepts, but that doesn’t absolve you completely of the responsibility to learn about the rules and regulations that govern your retirement accounts.
One of the most important that you’ll want to become familiar with is the required minimum distribution (RMD). RMD rules dictate how much money you are required to withdraw from your retirement accounts in retirement, and falling afoul of those rules can cost you thousands of dollars of your hard-earned money.
Some investors may not know about RMDs, or they may miscalculate the amount they’re required to distribute. Others may let RMDs sneak up on them, resulting in a bigger tax hit than they were expecting. Don’t let these mistakes happen to you. Learn more about RMDs so that you’ll be prepared when the time comes for you to take yours.
RMDs in a Nutshell
For decades, American investors have been able to invest in tax-advantaged investment vehicles. Conventional retirement accounts such as 401(k) and IRA accounts allow investors to use pre-tax dollars from their salaries to make investments. These then accrue tax-free until distribution, and taxes are then assessed when assets are distributed from these accounts.
More recently, Roth accounts, including Roth 401(k) and Roth IRA accounts have become popular. These Roth accounts allow investors to use post-tax dollars to invest. Investments accrue tax-free and then no taxes are assessed at distribution.
These tax advantages were passed into law to stimulate Americans to invest for their retirement. Investing through conventional brokerage accounts required using post-tax dollars. Then gains were taxed again, a form of double taxation. The benefit to tax-advantaged retirement accounts is that taxation only occurs once, thus allowing these accounts potentially to accrue greater investment gains over time.
Of course, the government doesn’t want to give anyone too much of a good thing, and thus 401(k) contributions and IRA contributions are limited in the amounts you can contribute each year. The government also doesn’t want to keep retirement assets completely free from taxation, as it wants its pound of flesh at some point. And there is where required minimum distributions come in.
If there were no RMDs, you could keep your retirement savings sheltered from taxes indefinitely, then turn them over to your heirs, and all that money could gain value for years without taxes being paid. To keep that from happening, the government requires investors to begin taking distributions after a certain age.
What Age Does an RMD Start?
Currently, investors are required to begin taking RMDs after they turn age 72. That’s a relatively recent increase from the previous age of 70½, and a change that many investors may not be aware of.
There are ongoing discussions in Congress about possibly raising the RMD age to a higher age like 77. There are even proposals to do away with the RMD altogether.
That wouldn’t be because the government has suddenly had a change of heart, but rather because it realizes that the economy is weakening and that many more people are going to be relying on their retirement funds. Eliminating RMDs would allow them to keep money that they don’t need to distribute in their retirement accounts earning investment gains, so that they can have more income in the future when they really need it. After all, why would you want to distribute money and pay taxes on your gains if you didn’t really need to take a distribution?
This will be an important area for you to keep track of this year, as there will likely be large stimulus and spending bills passing Congress, and a high likelihood that changes to RMDs could work their way in at some point. That could affect the availability of your retirement savings in a significant way.
What 401(k) and IRA Plans Have an RMD?
In general, there are four major types of retirement accounts that most investors might choose from: a 401(k), an IRA, a Roth 401(k), and a Roth IRA. There are also other accounts similar to 401(k) accounts, such as 401(a), 403(b), 457, TSP, and Solo 401(k) accounts. Finally, there are SEP IRA and SIMPLE IRA accounts. Each of these accounts has its own rules and regulations regarding eligibility, contribution limits, and RMDs.
With regard to RMDs, Roth IRA accounts aren’t subject to RMDs during the lifetime of the original account owner. All the other commonly held retirement accounts are subject to RMDs.
It’s important to note that RMDs were suspended for 2020, so that no RMDs were required. That suspension has not been extended into 2021 yet, but there is a definite possibility that Congress could decide to continue that extension, so that’s something else to keep an eye out for.
How Do I Calculate My RMD?
The amount of money you will have to take as an RMD is determined by a formula that takes the amount of money you have in your retirement accounts and divides that by a number from a life expectancy table. To calculate your own specific RMD, you can get a rough estimate from online RMD calculators. For more specific information, you may want to consult with your tax advisor.
If you have multiple retirement accounts, you can under certain circumstances take your RMD from a single account rather than from each individual account. If you have multiple IRA or 403(b) accounts, for instance, you can sum the total of those accounts and withdraw from one account. So if you have a Traditional IRA, a gold IRA, and a SEP IRA, you can add the total assets of all three accounts, figure your RMD, and take that entire RMD amount from one account.
If you have a Traditional IRA, a silver IRA, and two 403(b) accounts, you can add the totals of the IRA accounts, calculate the RMD, and take the IRA RMD amount from one account. You then need to figure out your 403(b) account assets, calculate your RMD, and can then take your 403(b) RMD amount from one of the 403(b) accounts. But you cannot take an IRA RMD from a 403(b) account, or vice versa.
401(k) accounts need to be individually calculated, and RMDs from 401(k) accounts need to be taken from each individual account. Roth 401(k) accounts are also subject to RMDs. Roth IRA accounts are not subject to RMDs, and distributions from a Roth IRA do not count toward your annual RMD requirements.
Failing to take an RMD will result in a 50% penalty on the amount of money that you didn’t distribute. So if you were supposed to distribute $6,000 but you only distributed $5,000, you would owe $500 in additional penalties. There are waivers for those who fail to take sufficient RMDs, but you’ll want to consult with your tax advisor about that.
The retirement planning landscape is changing all the time, and legislative action could continue to change the rules and regulations surrounding RMDs, possibly in ways that could benefit you. You need to stay informed, consult with your financial advisor and tax advisor about changes that you may not be aware of, and stay abreast of your financial situation.
Taking RMDs doesn’t have to be difficult, but it does require a little bit of work and calculation on your part. Make sure that you stay informed, so that you don’t inadvertently harm your retirement by making mistakes that could negatively impact your retirement savings.