You’ve worked hard and saved diligently for your retirement. Now that you’re entering this new chapter, it’s important to understand how Required Minimum Distributions (RMDs) work to avoid potential financial pitfalls. Mistakes with RMDs can lead to penalties that could deplete your retirement savings faster than expected. Here’s what you need to know about RMDs and how to manage them effectively.
What Are Required Minimum Distributions (RMDs)?
Required Minimum Distributions are the minimum amounts you must withdraw from your retirement accounts each year once you reach a certain age. Here’s a breakdown of what to expect:
Recent Changes in RMD Rules
- Age Increase: The Secure 2.0 Act has raised the RMD age from 72 to 73. This change is due to higher stock market gains and more retirees who need to start taking RMDs.
- Impact on Withdrawals: With this new age, the amount you need to withdraw could be higher, which might impact your overall retirement strategy.
Tax Implications of RMDs
RMDs are considered ordinary income and are subject to federal and state taxes. This can affect your financial situation in several ways:
Tax Bracket and Medicare
- Higher Taxes: RMDs can increase your adjusted gross income (AGI), possibly pushing you into a higher tax bracket.
- Medicare Premiums: A higher AGI might lead to increased Medicare premiums.
- Social Security: There’s also a chance that RMDs could make some of your Social Security benefits taxable.
Planning for Taxes
It’s important to set aside money for these taxes, especially when you first start taking RMDs, to avoid surprises at tax time.
Penalties for Not Taking RMDs
Failing to take your RMDs can be costly:
Penalty Details
- Hefty Fine: If you miss an RMD or fail to withdraw the required amount, you could face a 25% penalty on the amount you should have withdrawn.
- Tax and Penalty: You still need to withdraw the amount and pay taxes on it, along with the penalty. If you correct the mistake within two years, the penalty may be reduced to 10%.
Managing Your RMDs
Once you turn 73, you must take RMDs by December 31 each year. Here’s how to handle them:
Options for Your Withdrawn Funds
- Savings or Investment: You can put the money into a high-yield savings account or invest it in other assets.
- Charitable Donations: Donating to charity can be a tax-effective way to use your RMDs if you don’t need the money.
Roth IRAs and RMDs
Roth IRAs are different from other retirement accounts:
Key Points
- No RMDs: Roth IRAs don’t require RMDs because contributions are taxed when made. Earnings grow tax-free if you are at least 59½ years old and have had the account for five years.
- Inherited Accounts: RMDs apply only to inherited Roth IRAs.
Special Considerations
Certain situations might affect your RMD requirements:
Employment and Retirement Plans
- Current Employment: If you’re still working at age 73 and participating in an employer-sponsored retirement plan, you don’t need to take RMDs from that plan.
- Previous Employers: This exemption doesn’t apply to retirement plans from previous employers. Also, if your current employer’s plan requires distributions at RMD age or if you own more than 5% of the business, you’ll need to take RMDs.
Understanding and managing RMDs is crucial for maintaining your retirement savings and avoiding unnecessary penalties. By staying informed and planning ahead, you can navigate RMDs effectively and ensure a smooth transition into retirement.
What is an RMD?
An RMD is the minimum amount you must withdraw from your retirement accounts each year.
When must I start taking RMDs?
You must start taking RMDs at age 73.
How are RMDs taxed?
RMDs are taxed as ordinary income.
What happens if I don’t take an RMD?
You may incur a penalty of 25% on the amount not withdrawn, reducible to 10% if corrected within two years.
Are Roth IRAs subject to RMDs?
No, Roth IRAs are exempt from RMDs unless inherited.
