Revisiting the RMD

In the past few months, I have been getting a lot of questions from clients about required minimum distributions and how the latest legislation (SECURE Act in 2019, CARES Act in 2020) may affect retirement. This month’s article covers how required minimum distributions are calculated as well as the latest rules governing these distributions.

What are required minimum distributions?

Required minimum distributions (RMDs) were established by Congress to collect taxes from retirement accounts funded by pre-tax money. These include account types such as 401(k) plans, 403(b) plans, 457 plans, and traditional IRAs. The rules are essentially a government tool to increase tax revenue from assets that may otherwise be left in an account.

As an example:

Frank is 75 years old, has $725,000 in an IRA account, and can live on his social security and pension income each month. Since Frank doesn’t need the money within his IRA for living expenses, he prefers to keep his money invested to maximize his potential growth. Without RMDs, Frank would be able to leave his money in the account if he wished while continuing to defer taxes. However, current RMD rules require Frank to withdraw money each year from his IRA account. In 2021, Frank will be required to withdraw $31,659. This money will count as taxable income on Frank’s federal tax return.

When are individuals required to take RMDs?

An individual’s first RMD is required to be taken by April 1st of the year after they reach 72 years old. If Frank turns 72 in Nov 2020, he must take his first RMD prior to April 1st, 2021. For all subsequent years, the RMD must be taken by December 31st. Remember that if an individual chooses to take their first RMD between January and April of the following year, they will be required to take two RMDs (Age 72 & Age 73) in the same calendar year, potentially resulting in a higher tax bracket for that year.

How did the SECURE Act and CARES Act change RMDs?

The SECURE Act was passed in the fall of 2019. It had widespread implications for the rules which govern IRAs and certain kinds of trusts. Learn more about the wide range of changes incorporated into the law here. Many of these rules are not favorable from a tax perspective. However, one favorable rule change from the SECURE Act is the age at which RMDs must start.  The required age at which people must start RMDs used to be 70 ½, but has now been changed to 72.

The CARES Act was passed in the spring of 2020 as a stimulus package due to the economic effects of the COVID-19 outbreak. The CARES Act suspended all RMDs for the calendar year 2020. As of now, RMDs will be required once again in 2021.

What options are available after the RMD is distributed?

1. For those who need the money from their IRA, this taxable distribution can be spent on living expenses.

2. For those who may not immediately need the funds but still want access, the money left after taxes can be reinvested back into a taxable brokerage account.

3. For those who do not need the money and are charitably inclined, a Qualified Charitable Distribution (QCD) is an option. A QCD pays the distribution directly to a qualifying charity, bypassing the account owner and the taxes that would have otherwise been due. Learn more about QCDs here

Retirement takes a lot of planning. This includes estimating future expenses, calculating future sources of income, and including anticipated RMDs to obtain a realistic estimate of what the future may look like. If it has been a while since we’ve run these calculations, it might make sense to revisit your RMDs and their future impact on your financial picture.