RMD refers to the Required Minimum Distribution from a qualified retirement account. “Qualified” means that the retirement plan follows IRS rules.
Required: The distribution is required by the IRS because, essentially, it’s time to start paying taxes on those earnings. There are steep tax penalties if the RMD is not taken.
Minimum: Using life expectancy tables, the IRS sets a minimum percentage starting at under 4% of the portfolio and increasing from there. For retirees in their early 80s, the RMD is around 5%; in their mid-90s, it is around 10%.
Distribution: The distribution is a mandatory withdrawal starting when you turn 73 (or 75 if you were born 1960 or later) and every year thereafter. The IRS does not dictate what you do with the proceeds—only that it is now time to pay taxes as you take annual distributions.
A financial plan takes into account your individual needs so that RMDs can be put to best use.
For a retiree, we can look at how the RMD compares with expenses. For some people, the RMD could be earmarked for travel or hobbies. For someone else, it could supplement Social Security for household expenses. Someone else might use it for charitable giving to manage tax brackets or to support a grandchild’s education.
For someone decades away from retirement, a hidden question is if RMDs may result in too much income, increasing taxes in retirement. Diligent savers often wonder if they should make contributions to a traditional IRA or a Roth IRA. For a traditional IRA, you (generally) do not pay taxes on the money when you put it in the account, and then withdrawals (and RMDs) will be taxed. With a Roth IRA, you do pay taxes on the money when it’s contributed, and then withdrawals are not taxed.
We help clients think through their money today – is there capacity to contribute to a Roth account? Or could the tax savings of a traditional account be used to support life today? There are many unknowns when planning for retirement, especially what congress will do with the tax code. Given what we know now about the tax code, what might your tax brackets look like in retirement?
RMDs are one piece of the retirement picture – whether withdrawing money in retirement or saving and investing while working.
The fine print: There are a lot of RMD rules that I would feel remiss if I did not mention. The details can be different in each situation, and it’s important to learn the specific tax rules for your situation.
- The deadline for the first RMD is different from the deadline for later RMDs.
- If a spouse is 10+ years younger, RMD calculations have a slightly different formula.
- An inherited IRA has different rules from a contributory or rollover IRA.
- Rules are different for traditional and Roth accounts.
- IRAs and 401(k)s have some of the same rules and also different rules.
- Continuing employment (past retirement) may change RMDs for some retirement accounts.
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