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  • Evan Werckenthien

Understanding Required Minimum Distributions

Updated: Aug 4

Benjamin Franklin once famously said, “In this world nothing can be said to be certain except death and taxes.” I certainly would much rather talk about taxes than death, but I know not everyone can say the same. Pre-tax retirement accounts (such as 401(k), 403b, Traditional IRA, or other IRA-based plans – not Roth IRAs) are one break the IRS does grant us. Pre-tax retirement accounts offer the great benefit of tax-deductible contributions and tax-deferred growth (not having to pay taxes on the growth each year). What a nice break from the IRS! Well it is, but the IRS does eventually come knocking, in the form of a Required Minimum Distribution (RMD).

The year in which you turn seventy and a half, the IRS begins to collect taxes on your tax favored retirement accounts through RMDs. Sometimes the acronym RMD can be a buzzword getting thrown around without much understanding of what it is, so below are some common questions and answers along with other strategies to efficiently navigate your RMDs.

What is a RMD and why do I have to take it?

Required Minimum Distributions are annual distributions the IRS forces individuals over the age of seventy and a half to take. These distributions are generally from tax-favored retirement accounts that have not previously been taxed such as 401k, 403b, Traditional IRA, and other IRA based plans (not Roth IRAs). It is a way for the IRS to collect taxes on monies that have previously not been taxed. The distributions are treated and taxed as ordinary income.

When do I need to start taking RMDs?

Distributions are required to be taken starting the calendar year an individual turns seventy and a half. If your birthday is before July 1st, you will turn seventy and a half the same year in which you turn seventy. However, if your birthday is after July 1st, you will not turn seventy and a half until the following calendar year. The RMD can be taken in the form of a one-time lump sum, monthly distributions, or however you like. RMDs must be taken on or before December 31st.

What happens if the distribution is not taken?

If the distribution is not taken or the amount is not correct, there is a 50% penalty. The 50% penalty is levied on the RMD amount that was not distributed from the account. So if the RMD was required to be $5,000 and only $3,000 was distributed, there would be a 50% penalty on the remaining $2,000.

How are RMDs calculated?

They are determined by the IRS based on a life expectancy chart. In general, the percentage starts around 3.6% and increases little by little each year. The percentage is then multiplied by the pre-tax retirement account value(s), as of December 31st of the prior year. The total RMD amount can be taken from one account or prorated from all the accounts.

What if I do not need my RMD money?

For many people, RMDs are used to help supplement lost wages in retirement. In fact, some individuals take out more than they are required in order to support their income needs. For those who do not need to use their RMD money, the funds can be deposited and invested in a non-retirement account such as individual, joint, trust, or 529 college accounts.

Can the ordinary income tax be avoided?

Qualified Charitable Distributions could be a way to avoid having to pay taxes on your RMD. It is a direct transfer from your retirement account to a charity of your choosing. This type of transfer excludes the funds from being considered taxable income. Qualified Charitable Distributions do not require you to itemize your taxes, which is even more important now that the majority of Americans will be taking the standard deduction.

How can I plan distributions efficiently?

It is important to plan accordingly when taking RMDs. If monthly distributions are already being taken for supplemental income, make sure your RMD for the year is being factored into that. This will prevent double dipping into distributions for the year. This is especially important in the first year a RMD is taken. For example, an individual is taking $1,000 per month from a non-retirement account for income. They just turned seventy and a half and are now required to take a $13,000 RMD before the end of the year. If this was not factored in, the individual may have taken out $12,000 throughout the year via monthly distributions and then get stuck with having to take a one time $13,000 distribution as well. If planned properly, they should have been taking that RMD out monthly instead of taking distributions from their non-retirement account.

Retirement accounts make up the majority of assets for retired individuals.  It is very important to get your RMD plan in place before turning seventy and a half.  If your RMD is just extra money and not needed, remember that Benjamin Franklin also said, “A penny saved is a penny earned.”  For more information on RMD and distribution requirements, contact us or visit the websites below:

RMDs: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds

Life expectancy tables: https://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf

As always feel free to reach out to us with any questions,

Evan Werckenthien, CFP©


Evan@EWwealth.com

Work: 317-587-0858

Cell: 317-627-2529


Disclosure:

Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. E.W. Wealth Management and Cambridge are not affiliated. The information in this email is confidential and is intended solely for the addressee. If you are not the intended addressee and have received this email in error, please reply to the sender to inform them of this fact. We cannot accept trade orders through email. Important letters, email, or fax messages should be confirmed by calling 317-587-0858. This email service may not be monitored every day, or after normal business hours. Cambridge does not provide tax advice.

Source: Experian, Federal Reserve

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Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA / SIPC . Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. E.W. Wealth Management and Cambridge are not affiliated.

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