The recent news of the Securing a Strong Retirement Act—referred to as SECURE Act 2.0 because it builds upon the reforms of the original 2019 SECURE Act—passing the House of Representatives has brought potential changes around required minimum distributions back into the headlines. Instead of focusing on what those potential changes are here (which we’ll cover later in the year once we know what the final regulations look like), we want to address some of the most common questions we have been receiving from clients about required minimum distributions.
What is a required minimum distribution (RMD)?
An RMD is the minimum amount of money that must be withdrawn from an individual retirement account(IRA) or employer-sponsored retirement plan each year based on the U.S. Internal Revenue Code. For many of these plans, you’ve made pre-tax contributions throughout your career that have reduced your upfront taxes, so the IRS requires you to start withdrawing the funds at a certain age so that you can start paying income taxes on the value of the account.
Does this apply to all retirement accounts?
RMDs apply to most but not all retirement accounts. The accounts that require RMDs are profit sharing plans, 401(k) plans, Roth 401(k) plans, 403(b) plans, 457(b) plans, traditional IRAs, SEP-IRAs, SARSEP IRAs, SIMPLE IRAs, and inherited IRAs. Inherited IRAs have their own set of rules as to when RMDs begin, but we will address those rules more fully in a future article. The notable account type that is not included in this list is a Roth IRA, which has no RMDs while the owner is alive, since any contributions were made with after-tax dollars.
When do RMDs begin?
According to current law, when the owner of a retirement account turns 72, they must take their first RMD by April 1 of the following year. Each subsequent RMD needs to be taken by the end of the calendar year. Keep in mind, though, that if you delay your first RMD to April of the following year, you will have to take two RMDs in that year: one for the year you turned 72 and one for the current year. Also, if you don’t take your subsequent RMDs by the end of each year, then a 50% excise tax would apply for any amount of the RMD not received. So if your RMD is $100,000, you could face up to a $50,000 excise tax if you don’t withdraw that full amount in time.
There are a few exceptions to starting your RMDs at age 72. If you are still working, and your company retirement plan allows it, you are generally not required to take an RMD until you stop working.
How much is my RMD going to be?
In the words of my father, “it depends.” Your RMD is determined by a calculation that looks at your age, the fair market value of your accounts at the end of year, and a life expectancy table. You can work with your financial advisor, CPA, or custodian to determine your specific RMD.
Is my RMD going to be taxed?
Yes, and it will be taxed as ordinary income. Since the contributions you and/or your employer have been putting into your retirement account are excluded from your taxable income, and grew tax-deferred, any distributions will be taxed at your ordinary income rate.
What do I do with my RMD?
When it comes time to take your RMD, there are a few options available depending on what your goals are for the money. The most common option would be to deposit the distribution into your bank account to spend as normal. This can be done via check or direct deposit if your account is set up to do so. Another option is to have the money transferred to a taxable brokerage account, such as an individual account or trust account, so that the money can be reinvested, which allows your portfolio to continue to grow. Lastly, if your RMD is coming from an IRA, you can have your distribution made directly to a qualified charity using a qualified charitable distribution (QCD) starting at age 70 ½. This allows you to satisfy either all or a portion of your RMD without incurring a taxable event because the distribution will not be included as taxable income. QCDs do have a limit of $100,000 per year, though, so if your RMD is higher than that, you still have to withdraw the full amount from your IRA.
Taking your RMD provides an opportunity to pause, allowing you and your advisor to examine your retirement portfolios, consider tax implications, and create a plan for your distributions going forward.
This information is presented for educational purposes only and is not intended to constitute financial, tax, or legal advice. Morton Capital Management dba Morton Wealth (“Morton”) makes no representation that the strategies described are suitable or appropriate for any person. You should consult with your financial, tax and legal advisors to thoroughly review all information and consider all ramifications before implementing any transactions and/or strategies concerning your finances.