RMD Deadline is Approaching - Don’t Be Penalized!

As the end of the year approaches, investors over the age of 72 need to ensure they have taken their 2021 Required Minimum Distributions (RMDs). Congress’s CARES Act waived the requirement to take RMDs in 2020 as a form of COVID-19 relief. But they’re back in 2021!

What are RMDs?

Required Minimum Distributions are IRS-mandated withdrawals from your Traditional IRAs or Employer-Sponsored Retirement Accounts (such as 401ks) that you must take each year after turning 72 (70 ½ if you turned 70 ½ before January 1, 2020).

RMDs apply to accounts where you saved pre-tax dollars during your working years. These include Traditional IRAs, Rollover IRAs, SIMPLE IRAs, SEP IRAs, and most 401(k)s and 403(b)s. This does NOT include Roth IRAs - unless the account was inherited (read about the rules for Inherited IRAs here.)

How to Calculate RMDs

RMDs carry strict deadlines and are calculated by a specific formula. It’s important to be attentive and accurate when timing and calculating your RMDs.

The basic formula for calculating RMDs is: account balances as of December 31 of the previous year divided by the appropriate life expectancy factor as determined by the IRS’s Uniform Lifetime Table. If your spouse is the sole beneficiary and is 10+ years younger than you, your life expectancy factor is determined by the IRS’s Joint Life Expectancy Table instead.

For example, Jane turned 74 on July 2, 2021. Her IRA had a balance of $850,000 on December 31, 2020. Her husband, Joe, is 74 and is the sole primary beneficiary. Her life expectancy factor is 23.8 at age 74. Her RMD is $34,412.96 for this account in 2021.

Note that your RMD is calculated on the value of ALL applicable deferred tax accounts, but you can take the RMD from any account.

There are many resources to help ensure your calculation is accurate. Your custodian most likely has an RMD tool online. There are many RMD estimation calculators such as this one at Fidelity. If you are a Kings Path client, contact us for assistance or view your RMD status in our Client Portal.

Before taking distributions manually, you should check with your custodian if you have automatic withdrawals set up in order to avoid accidentally doubling up.

Timing & Penalties of RMDs

RMDs are not taken until age 72 (if you are still working, you may not have to take RMDs from your workplace retirement plan). Your first RMD must be taken by April 1 in the year after you turn 72. The deadline is December 31 every year after that. You may not want to delay your first RMD to the following April after you turn 72 as you would then have to take two RMDs in the same year – you should speak with your advisor about the tax efficiency and your personal needs.

If you miss your RMD deadline, the penalty is steep and one of the harshest penalties given by the IRS - 50% of the amount due! It may be beneficial to ask your custodian to set up automated withdrawals.

If you have failed to take previous RMDs, there are measures that can be taken to request penalty forgiveness from the IRS. This is a tedious process but may be worth the time and effort depending on the overall size of the penalty.

Taxes

When you take an RMD, it is taxed as income, counting towards your adjusted gross income (AGI) and taxable income for the year. This extra income may impact your marginal tax bracket, the taxation of Social Security benefits and Medicare premium costs, so once again annual planning becomes very important.

Two Alternatives to RMDs

Of course, you can take RMDs and simply spend on lifestyle expenses or re-invest to a taxable brokerage account. But, there may be more tax-efficient and strategic ways to use/avoid RMDs.

Roth Conversions

You can avoid or reduce RMDs in the future by converting traditional IRA money to a Roth IRA via a Roth Conversion. Roth conversions do not satisfy the RMD requirement so you must take your current year RMD and pay taxes before doing the conversion. If done in the same year, you’d owe tax on the conversion and the RMD so you should plan wisely around the extra taxable income. It would, however, reduce future RMDs and taxes.

If you plan to leave the Roth IRA to heirs who will be in a lower tax bracket or to a charity, it may not be tax-efficient to convert.

Be mindful as Roth Conversions have been the subject of several proposed legislations lately and the rules could change.

Benefits of Roth Conversions

• Reduce or eliminate future RMDs.

• Reduce or eliminate future taxed withdrawals.

QCDs

Qualified Charitable Distributions (QCDs) are direct transfers of funds from your IRA to a qualified charity. QCDs can be counted toward or totally satisfy (a limit of $100,000 can qualify for a QCD annually) your required minimum distributions for the year. QCDs are not included in your taxable income, whereas regular RMDs are. So, using a QCD to satisfy or count toward your RMD may reduce the impact to some tax credits and deductions, including taxation of Social Security benefits and Medicare premium costs.

For charitably inclined individuals in RMD mode, this can be a great opportunity to harvest the large current standard deduction and get full deductible value for the gifts you already planned on making.

Benefits of Qualified Charitable Distributions

• Reduce taxable income.

• Reduce impacts on your Social Security and Medicare.

• Be a blessing to others.

Plan Ahead & Watch for Changes

As you plan ahead in retirement, be thoughtful about how to use RMDs as efficiently as possible and within the limitations of the IRS. Furthermore, be attentive as legislation surrounding RMDs could change! The House Ways and Means Committee proposed to reduce the under-payment penalty, increase RMD starting age to 75 by 2032, and increase catch up contributions over age 60. However, it is all pending.

If you need help thinking strategically about your retirement, contact us today to learn more about our planning and investment management services.