Retirement Distributions

Transitioning into retirement can be exciting and daunting.  Many retirees work with a professional financial advisor to navigate the complexities.

Required Minimum Distributions (RMDs).  The IRS requires that you begin taking distributions from retirement plans at a certain age.  This is known as your Required Minimum Distribution (RMD) age.  Not too long ago, you did not need to begin your RMD until age 70½.  In 2019, Congress changed the RMD date to age 72.  In the final hours of 2022, Congress changed the RMD age yet again as part of the SECURE 2.0 Act!  If you were born in 1951 to 1958, your new RMD age is 73.  If you were born in 1959 or later, your RMD age will be 75.

Your RMD is calculated each year based on the value of your account on December 31 and your life expectancy according to an IRS table.  Your initial RMD is typically about 4-5% of the value of the account, and this increases a little bit every year.  If you fail to take your RMD, there is a penalty tax between of 25% per year!!!  So, it is important to pay attention to your RMDs.  RMDs need to be calculated for ALL retirement accounts, such as IRAs, 401k plans, 403b plans, etc.  Also, if you have multiple types of accounts, such as an IRA and 401k, you need to take a distribution from both of them.  Roth IRAs do NOT have a required distribution, unless received as an inheritance.

I should also note, if you INHERITED a retirement plan, the RMD rules are entirely different.  You are generally required to begin RMDs immediately, unless the plan is inherited by a spouse.  The inherited RMD rules are too complex to explain in this article, so please speak with your tax and/or financial advisor.

Distributions from retirement plans are generally taxed as ordinary income (unless you made Roth contributions).  Because of this, many people try to delay retirement distributions as long as possible.  For example, you may have money in non-retirement investment accounts or Roth IRAs that you can spend down during initial years of retirement. 

Tax Strategies.  It may seem counterintuitive to pay taxes sooner than you are required, but it may make sense to take some distributions from your retirement plan sooner than your RMD age.  The IRS has a graduated income tax schedule, meaning that as your income increases, your tax rate on income goes up.  The Federal tax rate starts at 10% and eventually increases to 37%.  Depending on the size of your retirement accounts, your tax rate may be higher if you wait until your RMD age.  For example, you may be able to pull money from your retirement plan and have it taxed at 12% or 22%, but this may go up to 24% or 32% later in retirement.  Paying taxes today at 12%, may be better than deferring taxes and paying at a rate of 24%, for example.

If you are over the age of 70½, it is possible to donate money from your retirement plan directly to charities without paying taxes.  This is called a Qualified Charitable Distribution (QCD) , and is a great strategy if you regularly donate to charities.  You don’t have to pay taxes on the distribution and your charities directly benefit!

Roth Conversions.  If you want to take advantage of lower tax rates but don’t need money for your expenses, you can also consider a Roth Conversion.  When you do this, you convert a taxable retirement account into a Roth IRA, which grows tax free!  Roth IRAs do NOT have RMDs, so the money can grow tax-free until your death.

Lars Lambrecht, Rehoboth resident and Certified Financial Planner, is available to answer questions or meet for a consultation.  617-947-6428