Understanding RMDs

What are Required Minimum Distributions or RMDs? If you are closing in on age 73, you may have heard about this force-out of income from your pre-tax IRAs and 401(k)s. Essentially what it means is that you are required to take taxable income from your retirement accounts each year. This RMD amount increases each year and levels off around age 84-85, where it starts to decline. If your account balance is also increasing in value, the RMD may also increase along with it. As an example - and you can run this yourself at https://www.schwab.com/ira/ira-calculators/rmd - suppose we have a client with a $1m balance right before age 73. The graph below shows the RMD profile and how it tapers off past age 85:

Is this a good thing or a bad thing?

It depends. A lot of times what we see is that the client is already receiving social security and maybe a pension or two (or an annuity), which satisfies all of their income needs. So now they have to account for this extra income each year, which throws a wrench into their 1040. It may push them into a higher tax bracket and/or make more of their social security taxable where it wasn't before. This situation is common - we're all educated early on to invest our retirement account as pre-tax dollars so that our taxable income is lower and we keep more of our paycheck.

What can we do about it?

If you are mid-career and building up a solid pre-tax balance in your 401(k) or IRA, it may be time to balance that out with some Roth contributions and/or perform some Roth conversions. This depends on your current financial and tax situation. As we know, any Roth money is after-tax. If you are just starting out in investing, you have the opportunity to start with Roth 401(k) or Roth IRAs now. If you are close to age 73, then we would examine ways to offset the tax with various strategies and help mitigate the RMD taxable income impact.

If you are in retirement now and you need to pull from your accounts for income anyway, the RMD may not present a big issue, and we simply manage the taxes year to year, and look for ways to offset the impact, as we can.

What happens if I forget to take the RMD?

The penalty rules have gotten better on this. It used to be quite punitive - before 2023 and the SECURE Act 2.0 it was a 50% tax on the amount you should have withdrawn. The current penalty is 25% and reduced to 10% if corrected in a timely fashion (within 2 years).

Do you have any other questions on RMDs and ways to prevent or mitigate the RMD future force-out of income? Not sure how it might affect retirement income distribution and your tax return? Please reach out and let us know! We can run an analysis on this and come up with some custom strategies for your situation.

Blessings