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Published on: 11/14/2023 • 7 min read

What Are RMDs?

What are RMDs? RMDs, or Required Minimum Distributions, represent a crucial part of retirement planning. Understanding the concept of RMDs and the role they play in your retirement plan is fundamental, especially for high-net-worth retirees, business owners, and families. Why? RMDs can have significant income tax implications and failure to take them on time can result in serious penalties.

This article aims to delve deeper into the intricacies of RMDs, providing you with the necessary insights to make more informed decisions about your retirement finances.

What is an RMD and how does it work?

Required Minimum Distributions (RMDs) are essentially the minimum amount that the IRS requires you to withdraw from your retirement accounts annually once you reach a certain age, with distributions proportionately going up every year. 

In the first year you are required to take a RMD, it can be taken either within that year or by April 1st of the following year. For all subsequent years, you must take your RMD by December 31st. 

It is important to understand your income and tax obligations before deciding when this first RMD should be taken. Because distributions from the accounts in question generate an ordinary income tax obligation, proper planning around RMDs can help you maintain a steady flow of income during retirement while working to minimize the potential tax burden and avoid incurring heavy penalties.

How do I know if I have to take an RMD? Here are a few account types these rules apply to:

  • Traditional IRAs
  • SEP IRAs
  • 401(k) plans

Roth IRAs do not require RMDs during the account holder’s lifetime and, starting in 2024, Roth 401(k)s will no longer require RMDs. 

For a visual and more comprehensive understanding of RMDs, watch the video below to hear from Avidian advisors Greg Litts and Thomas Brown for more detailed information about RMDs.

How are RMDs calculated?

Your RMD is calculated based on your life expectancy and your account balance as of December 31st of the prior year. If you have multiple retirement accounts you can choose to take your total RMD from one account, or a combination of the qualified accounts, as long as the total distribution meets the minimum requirement set by the IRS.

You can use IRS life expectancy tables to determine the exact amount or consult a financial advisor offering retirement planning services for assistance. These tables are set up so that as you age and your life expectancy goes down, the proportionate distribution that is required will go up.

Specific factors that influence the calculation of your RMD include:

1. Age

    At what age are RMDs required? Under the Secure Act 2.0, the age at which RMDs begin has been raised to 73 for individuals who turned 72 after December 31, 2022. For those who turned 72 before this date, the age at which you are required to take an RMD remains unchanged at 72. However, if you turned 70½ before January 1, 2020, you are still required to adhere to previous rules and take an RMD for the year in which you turned 70½. This is known as your Required Beginning Date (RBD).

    2. Account Balance

      Your account balance is the total value of all the funds in your retirement accounts at the end of the previous year. This includes traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, and other qualified retirement plans. The IRS requires you to calculate your RMD individually for each type of account that you have.

      3. Distribution Period

        The distribution period is a factor determined by the IRS to estimate how long you will live after reaching the age at which RMDs start. This period is based on average life expectancy and is used to determine the percentage of your retirement balance that must be withdrawn each year for RMDs. The IRS provides different distribution period tables based on the type of account and your marital status.

        4. Inherited accounts

          Special rules apply if you inherit a retirement account. For example, spouses are able to rollover their IRAs and 401k(k)s into their personal IRA. This can have a significant impact on when RMDs start, and how much needs to be distributed, as this option typically extends tax-deferred treatment when compared to other options. In most cases, beneficiaries will be required to withdraw the entirety of the inherited account over a 10-year period.

          Why are RMDs important?

          RMDs play a crucial role in retirement planning for several reasons:

          • Forced distribution of retirement savings. RMDs serve as a way to ensure that individuals are not hoarding their retirement savings and are instead using them to fund their retirement. This also helps to stimulate the economy, as pre- and post-retirees may use their RMDs for living expenses or invest them in other assets.
          • Tax implications. Because traditional IRA and 401(k) contributions are tax-deferred, withdrawals are taxed at ordinary income rates. By requiring individuals to take out a certain amount each year through RMDs, the government can collect the taxes owed on these distributions, making RMDs a crucial part of tax strategies for retirees.
          • Avoid penalties. Failing to take the required minimum distribution can result in significant penalties. The IRS can impose a 50% excise tax on the amount you should have withdrawn but did not. Additional penalties may be assessed if taxes are not properly paid on the RMDs taken, which is why it is typically advisable to have taxes withheld when taking a distribution (since this will simplify your tax reporting and obligations).

          Because of these factors, consulting with a financial advisor who specializes in high-net-worth retirement planning can help you navigate the complexities of RMDs and set you up to make the best decisions for your future.

          Continue reading: Where is the safest place to put your retirement money?

          What to do with your RMD if it’s not needed

          If you have enough income to cover your living expenses in retirement and don’t need the additional funds from your RMD, there are several options for what you can do with it:

          1. Reinvest it: You can reinvest your RMD in a taxable investment account or a tax-free Roth IRA. This allows you to continue growing your retirement savings while potentially minimizing the impact of taxes.
          2. Donate it: If you’re 70½ or older, you can make tax-free charitable donations of up to $100,000 per year directly from your IRA to qualified charitable organizations, which can count towards your RMD. This tends to be a great option for those looking to reduce their tax liability for the year and contribute toward a cause that they believe in.
          3. Gift it: You can also gift your RMD to family members or friends who are in need. However, there are tax implications to consider when gifting large amounts of money.
          4. Save it for a rainy day: Lastly, you can simply save your RMD in a savings or money market account as an emergency fund. This can provide peace of mind knowing that you have additional funds available in case of unexpected expenses.

          It’s important to consult with a financial advisor before making any decision on what to do with your RMD, as they can provide personalized guidance based on your individual financial situation and goals. Additionally, they can help with retirement income planning and help you plan for the potential impact of taxes to make sure that you are meeting all necessary requirements for RMDs.

          Create a comprehensive retirement plan for a financially secure retirement with Avidian Wealth Solutions

          So, what are RMDs? RMDs are the minimum amount of money that individuals with retirement accounts must withdraw each year starting at a certain age. These distributions serve as a way to ensure that retirees are using their savings and stimulating the economy while also generating tax revenue for the government. But if RMD payments aren’t needed, they can offer a great way to reinvest, donate, or gift funds for a greater purpose.

          With the help of a financial advisor who offers retirement planning, you can create a comprehensive plan to optimize your RMDs and plan for a financially secure retirement. At Avidian Wealth Solutions, we offer personalized retirement planning in Houston, Austin, Sugar Land, and The Woodlands that take into account your individual financial situation, goals, and risk tolerance.

          Whether you’re looking for retirement planning for small business owners or high-net-worth retirement planning, our multidisciplinary team can help you create a plan that works to set you up for success in retirement. Schedule a conversation with us today to learn more!

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