Required Minimum Distribution (RMD) Rules: Key Things Every Retiree Should Know

Terry Herr CFP®, CLU

Your required minimum distribution "RMD" is the minimum amount you must withdraw from your combined retirement account balances each year. You generally have to start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA of other retirement plan accounts when you reach age 72 (70½  if you reached age 70½  before January 1, 2020.)

CAUTION:  Due to COVID the 2020 RMD was waived. It's important you remember the IRS did not waive the 2021 requirement which must be withdrawn from one or more of your retirement accounts prior to December 31, 2021.

1. RMDs Depend on Your Age

The main point of RMDs is to keep money from staying tax-free forever. The government gave a temporary tax break to encourage you to save for retirement, but it still wants that tax money. A required minimum distribution is a required withdrawal from your retirement account. It counts in your taxable income just like any other withdrawal in retirement.

Currently, RMDs start when you hit age 72 (or 70½ if you turned 70½ prior to January 1, 2020) and they are calculated to empty your retirement account within your expected life expectancy.¹ Each year, you need to withdraw a certain percentage of your account with the percentage going up as you age. However, it's important to realize that you do not have to spend all of this money. You can also reinvest it into a taxable account.

2. Not Taking the RMD Can Mean Big Penalties

Thinking about skipping RMDs to avoid taxes? Think again. Not only do you still have to pay the taxes on the RMD amount, but you'll also owe a 50 percent penalty. 

For example, if you were supposed to withdraw $10,000 but didn't, you'll owe ordinary income tax PLUS the IRS will charge you an extra $5,000. The penalty repeats every year until you catch up on your RMDs from previous years.

Remember, you are responsible for your tax compliance, not your retirement plan custodian, CPA or advisor.  Herr Capital Management is proactive about helping you determine your RMD amounts, but it is important you make sure all retirement accounts are included, including those held at banks and other institutions.

3. RMDs Can Throw a Wrench in Your Tax Planning

There are many reasons why you might want to reduce your taxable income in retirement. These can include qualifying for things like Medicaid subsidies, avoiding taxes on your Social Security benefits, trying to stay in a lower capital gains tax bracket, or just wanting to pay fewer taxes.

Required minimum distributions can throw a major wrench in your tax planning because not only are they not avoidable, they can suddenly increase if the market surges. If you're using a tax strategy that requires reducing your income to a certain level, it's important to build in flexibility for your RMDs.

4. RMDs Can Be Avoided

There are still ways to reduce or even avoid RMDs altogether. The main idea is to get the money out of your retirement account when you want to not when the IRS wants you to.

One method is to make extra withdrawals at the end of the year. In December, you can estimate your taxes for the year. If you still have room in a lower tax bracket or below the income you need to stay under, you can withdraw additional money. When next year's RMDs are calculated, it will be on a lower account balance.

You may be able to plan ahead by converting some of your IRA to a Roth IRA. Roth IRAs don't have RMDs because the money has already been taxed. When you make the conversion, you pay ordinary income tax rates on the amount you converted. There are no penalties even if you do the conversion before you turn 59 1/2.

Want to learn more about RMDs and how to plan your tax strategy?  CONTACT US and we can help develop a personalized distribution plan that makes sense for you.