Both employer-sponsored retirement plans and individual retirement accounts (IRAs) can help boost your retirement savings. However, the Internal Revenue Code (IRC) requires that owners of IRAs and participants in qualified employer-sponsored retirement plans (QRPs) begin taking annual distributions from these accounts once they reach a certain age, known as Required Minimum Distributions (RMDs). An RMD establishes the minimum amount that must be taken from your retirement accounts, or "distributed" to you, on an annual basis.
While the rules governing these RMDs feel overwhelming at first, a bit of background information can help you better navigate this important aspect of retirement planning.
Who has to take RMDs?
RMD requirements vary on the type of account you hold. Most likely you will eventually take RMDs if you have any Traditional, Simplified Employee Pension (SEP), or Savings Incentive Match Plan for Employees (SIMPLE) IRAs. Likewise, if you have a QRP like a 401(k), 403(b), or governmental 457(b), you will have to take RMDs.
Meanwhile, Roth accounts, such as Roth IRAs and Roth 401(k)s do not have required minimum distributions.
When to begin taking RMDs
Your RMD date depends on when you reach your required beginning date (RBD). That date will depend on when you were born:
- If you were born in 1951 or earlier, you must take your first RMD by April 1 following the year you turn 72.
- If you were born between 1952 and 1959, you must start taking RMDs By April 1 following the year you turn 73.
- If you were born in 1960 or later, you must take your first RMD by April 1 following the year you turn 75.
Depending on your retirement plan, you may be able to delay taking RMDs. For instance:
- If you are 73 or older and still working for an employer that sponsors your qualified employer sponsored retirement plan, you may be able to defer RMDs from that plan until April 1 of the year after the year you retire. However, if you own more than 5% of the company sponsoring the plan, you will still need to take your RMDs beginning at age 73.
You may also have the option to delay your first RMD depending on when you were born. However, you’ll have to take your RMD by December 31 of each year, so if you choose to delay in your first year, you will likely need to take two distributions by the end of that year: the delayed first RMD and the second RMD. Keep in mind that both will be taxable as ordinary income.
Key RMD rules to remember
Keep in mind that not complying with RMD regulations can result in penalties. Here are guidelines to help you stay on track.
- Calculating your RMD: Your RMD is determined by dividing your retirement account balance at the end of the previous year by the appropriate life expectancy diVisor from the IRS Ufe Expectancy Tables, based on your age as of December 31 of the current year. To help calculate your RMD1 consider using the RMD calculator offered by the Financial Industry Regulatory Authority (FINRA).
- Special considerations for spouses: If your spouse is the sole beneficiary of your accounts that are subject to RMDs and is more than 10 years younger than you, you can use the IRS Joint Life Table to calculate RMDs. This table results in a larger life expectancy divisor and smaller RMDs, offering a bit more flexibility.
- Penalties for under-distribution: If you do not make your full RMD, you may face a 25% IRS tax penalty on the shortfall. This penalty can be reduced to 10% if you correct the shortfall within a two-year correction window. You can always take more than the minimum without penalty.
- Multiple IRAs and QRPs: If you have more than one IRA, calculate the RMD for each account separately. However, you can aggregate the total RMD amount and take it from one or multiple IRAs. For QRPs, you must calculate and take RMDs from each plan separately.
- Inherited IRAs and Roth IRAs: RMDs for Inherited IRAs must be handled separately from your other IRAs. Roth IRAs do not have RMD requirements for the original owner, which may provide a bit of relief in your planning.
Tax implications of RMDs
RMDs are generally taxed as ordinary income in the year they are taken. If you have after-tax contributions, or "basis," in your IRA, you will want to work closely with the tax advisor to ensure the distribution is handled properly on your tax return.
Additional considerations for your retirement accounts
To make an IRA contribution, you or your spouse (if filing jointly) must have earned income. Contributions to Traditional and Roth IRAs can be made at any age if you meet the eligibility requirements. If you're still working, you (if self-employed) or your employer can make employer contributions to a SEP, and you can make salary deferral contributions to your SIMPLE IRA.
Converting to a Roth IRA is an op tion at any age and regardless of their modified adjusted gross income (MAGI) or tax filing status. Traditional, SEP, and/or SIMPLE IRAs can be converted to Roth, but a SIMPLE IRA can be converted only after the account has been funded for two years. When deciding if a Roth IRA is right for you, you should consider factors like current or future tax rates, investment returns, what the money will be used for and when, income, and marital status. Keep in mind that if you're 73 or older, you must take your RMD before conversion and RMD amounts are not eligible to convert. If you have questions about whether converting to a Roth IRA is right for you, consider consulting a tax advisor to look at your unique accounts and financial situation.
As you begin taking RMDs, consider how you'll use this money. You aren't required to distribute cash: you can also distribute securities. These assets can be transferred to a non-retirement account, such as a WellsTrade® brokerage account, a CD, or an annuity, or may be used to cover expenses. They may also be donated to charity.
We are here to support you in your retirement journey and help ensure you have the resources and support to make informed decisions. For personalized guidance, reach out to your Financial Advisor, or find an advisor, or call us to learn more at (866) 224-5708.