How to Navigate Required Minimum Distributions (RMDs)

Our topic on this episode of the Ready for Retirement podcast is about understanding how to navigate Required Minimum Distributions (RMDs).

Questions answered: What do I need to know about RMDs? How do I calculate RMDs? What tax strategies can I implement to avoid or limit RMDs? What is the best approach for my individual situation? 

Are you ready to start focusing on the things that truly matter when it comes to your financial future?

Key Points

• What is a Required Minimum Distribution?
  • An amount of money you are required to begin distributing from your pre-tax accounts starting at age 72.
    • Examples: Traditional 401(k)s, IRAs, 403(b)s, 457, etc.
    • The IRS incentives individuals to save for retirement and pre-tax accounts are a great way to do so.
      • This saves you on money today, but you must pay taxes when the money comes out.
    • After age 72, you are forced to take a certain % from your pre-tax account each year.
• How do RMDs work?
  • When you turn age 72, you will be required to start taking money from pre-tax accounts.
    • The RMD for your own IRA or 401(k) is age 72, but if you inherit an account (Roth or Traditional), you must distribute the entirety of that account over 10 years.
      • This does not apply to Spousal Inheritance. 
      • If you inherit an IRA from someone other than your spouse, you have 10 years to distribute the entirety of that account.
• What accounts don’t require me to take RMDs?
  • Roth IRAs, Roth 401(k)s, Taxable/Individual accounts, and 401(k)s if you’re still working and less than a 5% owner, RMDs are not required until you are done working, 
• RMDs
  • The first RMD must be taken by April 1st of the following year after you turn age 72.
    • Example: If you turn 72 on April 1st of 2020, your first RMD is required on April 1st of 2021.
  • Subsequent RMDs must be taken by December 31st of each year on an ongoing basis.
    • Example: If you turn 72 in 2021, you could push your first RMD until April 1st of 2022. Let’s assume you take your first RMD April 1st, 2022.
      • This satisfies the 2021 RMD.
      • Your 2022 RMD must still be taken by December 31st of 2022.
• RMD Penalties
  • If you miss an RMD, there is a 50% penalty of the amount that’s not taken.
    • If you have a $20,000 RMD and fail to take it, there would be a $10,000 penalty. 
    • Understand what needs to be taken and when it needs to be taken by to ensure you avoid penalties.
• How much do I have to take for RMDs?
  • This is determined by the life expectancy of a table provided by the IRS.
  • Divide your IRA balance (or other account that requires RMD) by 25.6 (found by the table) which gives you a withdrawal rate.
    • RMDs increase as life expectancy decreases.
      • Example: At age 72, your life expectancy is 25.6 additional years. 
        • 1/25.6 = 3.9%
      • Example: At age 80, your life expectancy is 18.7 additional years. 
        • 1/18.7 = 5.3%
      • Example: At age 100, your life expectancy is 6.3 additional years.

• How are RMDs calculated?
  • Example: Let’s assume you have $1,000,000 and it’s the first year you must take your RMD.
    • 3.9% is required to be taken as of December 31st, 2020 as of last year. 
      • If your account balance was $1,000,000, you would take 3.9% and multiply by $1,000,000 to get a RMD of $39,000.
      • $39,000 is the RMD this year
    • If by December 31st, 2021 the value of the account did not grow and was still $1,000,000, the RMD would still increase due to life expectancy.
      • It is likely $41,000 or higher, depending on life expectancy.
• How do I take RMDs?
  • RMDs can be taken as a lump-sum and you can withhold taxes to ensure you don’t owe a large amount in taxes when you file for taxes.
  • RMDs can also be taken monthly.
    • Example: Assume you have $1,000,000 in your portfolio and you have a $40,000 RMD.
      • You can divide $40,000 by 12 to ensure you receive RMDs on a monthly basis to cover living expenses, a trip, etc.
    • The IRS allows you to take RMDs monthly, quarterly, bi-weekly, etc.
• RMD Strategies
  • What if I’m retiring and don’t need additional income?
    • You can’t leave the funds in your IRA without penalties, but you can take the funds out, pay the taxes owed, and reinvest the funds in an individual/taxable account.
• How are RMDs taxed?
  • RMDs are taxed as ordinary income.
  • RMDs can not be converted into a Roth IRA, but you can convert funds above the required RMD limit.
• Qualified Charitable Distributions (QCDs)
  • With a Qualified Charitable Distribution (QCD), you can give funds from your IRA directly to your non-profit of choice.
    • The benefit is that this does not show up as a taxable distribution on your tax return.
    • Rather than taking $10,000 from your IRAs, paying taxes, and giving the funds to your charity, you can give the funds directly to your charity which avoids taxes.
      • You can give up to $100,000/year in the form as a Qualified Charitable Distribution (QCD).

Timestamps

1:44 – What are Required Minimum Distributions?

3:50 – Understanding Inherited & Spousal IRAs

7:00 – When Do RMDs Start?

9:22 – Life Expectancy Examples

11:22 – How RMDs Work

13:42 – RMD Timing

15:12 – How are RMDs Taxed?

17:25 – Qualified Charitable Distributions

19:00 – Aligning Your Investments With Your Financial Goals

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