Whether you’re approaching retirement or you’re already well accustomed to your new lifestyle after working, there are important things you need to know about RMDs. If you’re included in the former group you might be wondering, what is a required minimum distribution?
This money is a required withdrawal taken out of qualified retirement accounts on an annual basis. But, even if you know this already, you might not be aware of the updates implemented with the SECURE 2.0 Act.
A required minimum distribution (RMD) is a mandatory annual withdrawal individuals must take from their retirement accounts, such as traditional IRAs and 401(k)s, once they reach a certain age. The purpose of RMDs is to ensure that individuals do not accumulate tax-advantaged retirement savings indefinitely and begin withdrawing funds to support their retirement lifestyle. Individuals must start taking RMDs at 73, as per the current IRS guidelines.
The amount of the RMD is calculated based on your life expectancy and the account balance at the end of the previous year. But, keep in mind, failure to withdraw the required amount may result in substantial tax penalties. So, it’s best to stay informed about RMD rules and deadlines to avoid potential financial repercussions, especially if you’re coming up on your RMD payment due date.
If you are already familiar with RMDs then you may be confused about the age mentioned above. Well, the 2023 SECURE 2.0 Act raised the minimum age for RMDs from 72 to 73. And, in 2033, the age for RMDs will once again increase to 75 years old.
In addition to the age for RMDs, the SECURE 2.0 ACT introduces some other important updates as well. For one, the IRA-qualified charitable distribution limit increased in 2023. This limit is linked to inflation, so the limit increased from $100,000 to $105,000. If you are older than 70 ½ in 2024, you can make a qualified charitable distribution in place of your RMD.
Further, the new update allows Roth 401(k) account holders to be exempt from RMDs. As of 2024, Roth 401(k)s will be aligned with Roth IRAs, which don’t require distributions during retirement. Before this update, retirees with a Roth 401(k) had to transfer the account to a Roth IRA in order to bypass RMDs. But now, this extra step is no longer needed.
Ultimately, SECURE 2.0 applies numerous additions to RMD rules, with key highlights involving a raised age for the commencement of RMDs from both IRA and 401(k) accounts for retirees. Plus, this legislation aims to facilitate continued savings for younger individuals managing student debt, streamline the process of moving accounts between employers, and allow people to set aside funds for emergencies within retirement accounts.
While the age increase and updates to RMDs for Roth accounts are perhaps the most notable features of SECURE 2.0, there are other important features to be aware of in order to ensure you are properly planning for retirement.
It's crucial to be aware of the deadlines associated with mandatory withdrawals from retirement accounts. While there's a grace period for the initial RMD, subsequent RMDs must be taken annually. If you're turning 73 in 2024, you have the option to take your first RMD by December 31, 2024, or you can choose to delay it until April 1, 2025 if needed. Understanding and adhering to these timelines is essential to ensure compliance with regulatory requirements and to make informed decisions regarding your retirement planning.
RMDs are withdrawn from retirement accounts funded with pre-tax dollars, which creates a deferred tax liability. When you decide to take RMDs, it's important to note that income tax must be paid on them, and the amount is based on your current tax bracket. But, there's a notable exception – RMDs taken from a Roth 401(k) are tax-exempt, providing a tax advantage for those specific distributions.
We’ve touched on it a little bit so far, but only certain retirement accounts are subject to RMDs. These qualifying accounts include:
You might have other accounts and be left wondering whether there is a required minimum distribution for those. Fortunately, your checking and savings accounts aren’t ones that you need to be concerned about for RMDs. And, now that Roth 401(k) accounts have joined Roth IRAs as non-qualified plans, you also don’t need to worry about those. Some other non-qualified accounts include stocks, bonds, individually owned mutual funds, as well as non-qualified retirement plans and annuities.
If you don’t take RMDs, you might find yourself facing significant tax penalties. Prior to the updated RMD guidelines, the penalty for neglecting to take RMDs was equal to 50% of the amount that should have been withdrawn. However, as of 2023, this penalty has decreased to 25% of the amount that should have been withdrawn from qualified accounts.
As an example, let’s say you were required to withdraw $8,000 from a qualified account, but you missed the deadline. You would be required to pay an additional $2,000 in penalties to the IRS. So, in order to avoid these penalties, it’s important to stay informed about RMD deadlines and take appropriate actions to meet them.
To calculate your RMD, you’ll need to divide the account balance of your tax-deferred retirement account by a life expectancy factor, which is outlined in the IRS’s uniform lifetime table. When using this calculation method, it’s best to use the account balance as of December 31st of the previous year. So, if you were to calculate your RMD in 2024, you would use the following formula:
December 31st account balance / Life expectancy factor = RMD
The resulting number represents the minimum amount you must withdraw for the current year to meet RMD requirements.
Immediate annuities can be used to satisfy RMD obligations if structured appropriately. For one, immediate annuities are exempt from RMDs because there is no cash value to use for RMD calculations. By purchasing an annuity, you are moving your money to an insurance company and receiving regular income payments where the value of those payments remains the same. So, since RMDs require withdrawals to increase, immediate annuities can’t be structured into this process.
In contrast to immediate annuities, deferred annuities held in a tax-deferred account will be subject to RMD payments. But, this is only applicable to qualified annuities. Retirees should carefully coordinate their annuity withdrawals with RMD obligations to ensure they meet regulatory guidelines and maximize the benefits of their retirement income strategy.
The main takeaways from RMDs are the increased age requirement and updates to Roth accounts. But, with these changes, it’s imperative to stay informed of all guidelines associated with RMDs so you don’t face unwanted penalties.
To avoid these penalties and ensure you’re making smart decisions ahead of retirement, it’s always best to consult with a professional. Fortunately, ELCO Mutual’s independent insurance agents are ready to help you navigate life insurance and annuities to maintain financial security throughout retirement. To learn more, connect with an agent today!