Take your MONEY (or ELSE)! The RMD (Required Minimum Distribution)

INSIGHTS for INVESTORS

When the Individual Retirement Account (IRA) was established in 1974 it was set up to be funded solely by pre-tax dollars giving you the benefit of reducing your taxable income and letting your capital grow tax deferred, but with it came the RMD (Required Minimum Distribution.) The purpose of the RMD? To ensure that IRAs couldn’t grow tax deferred indefinitely and the government could secure their portion of the tax revenue they allowed you to defer within your lifetime.

Fun fact – the 401k started in 1978 and the Roth IRA was established next in 1997 with the latter allowing folks to pay their taxes the day they make their IRA contributions, thus allowing those contributions AND gains to be withdrawn tax free. As a result, Roth IRAs aren’t subject to RMDs within the individual’s lifetime (the government already received their taxes).

In 2020 the SECURE ACT was passed, changing the RMD age from 70.5 to age 72. The old rule stated you needed to take your RMD prior to April 1^st of the following year in which you turned 70.5. Now it’s April 1^st the year after you turn 72. Following the first year, the RMD is required to be withdrawn from your IRA prior to year-end or you may be hit with a 50% penalty assessed on the amount of RMD you should have taken. YIKES!

I want to dig into some of the key “ins and outs” to know around the RMD:

1. Pre-tax IRAs, SEP IRAs, SIMPLE IRAs and many pre-tax Defined Contribution plans (401k, 403b, and 457b) are subject to RMDs.
   
   Almost all qualified accounts are subject to the RMD rules. The government allowed for the benefit of growth on tax deferred accounts to help with one’s retirement but wants to ensure they see the tax revenue at some point – even if the money is inherited.
   
   
2. The RMD is calculated based off the Dec. 31^st value of the account and then divided by a determined life expectancy factor table.
   
   We should also note the RMD is calculated off ALL qualified accounts you have but taken in any combination from them. So, if you have $1M in an IRA and $500,000 in a SEP IRA, your ending year value will be $1,500,000 divided by your table rated life expectancy to reach the minimum dollar amount you need to take. You can always take more than this if your plan allows.
   
   
3. Roth IRAs and/or any Roth portion of a Defined Contribution are not subject to RMDs – except for inherited ones.
   
   In 1997 it all changed with the advent of the Roth. As noted, Roth’s are not subject to RMDs while the individual who owns the account is alive. If there is a balance in the account following the passing of said individual, the beneficiary is required to take the money out of the account within 10 years. The same timeframe rules apply to the pre-tax IRA except any non-spousal beneficiary will pay ordinary income tax versus getting the distributions tax free like the Roth. This assumes the Roth existed for five years prior to death.
   
   
4. Some Defined Contributions plans allow for one to avoid taking RMDs off their account if they’re still employed and don’t own 5% or more of the company.
   
   If you are age 72 and would be traditionally subject to take RMDs out of your 401kBUT you are still working and deferring with the employer of the 401k in question, you may not have to take RMDs if the plan allows for it. We’ve been able to help folks avoid unnecessary tax on RMDs by maxing their 401k contribution through their salary deferral (if they’re not doing so already) and using their RMD from other qualified accounts to live off in lieu of their income. That way they’re not subject to paying tax on their earned income and their RMD. This method could keep them from jumping into the next marginal tax rate.
   
   

An additional strategy is working with your CPA to determine the amount you can convert from your pre-tax accounts to your post-tax accounts on an annual basis without bumping up into the next tax bracket. This will help lessen your RMD when the time comes and give you the benefit of tax-free growth since Roth dollars aren’t subject to the RMD. This method may not make sense for high income earners.

I know what you’re thinking, this is one of the best written commentaries yet, so amazing (wink), but it has to stop somewhere, and I don’t want to overload you with too much lingo and RMD info. If you’re left wondering how RMDs may affect your financial plan do not hesitate to reach out. As always, we’re here to help, current client or not.

Have a great weekend,

Ben and the Team at Ten Capital