Understanding Required Minimum Distributions (RMDs)

December 13th, 2024

Estimated Reading Time: 8 Minutes

As the year comes to a close, it’s time to check off those last-minute financial tasks, and for many retirees, Required Minimum Distributions (RMDs) should be high on the list. RMDs are an essential part of managing tax-deferred retirement accounts like Traditional IRAs and 401(k)s, and they come with a hard deadline of December 31st. Whether you’re taking your first RMD or are a seasoned pro, now is the perfect time to review your plan, optimize your tax strategy, and make the most of your retirement savings.

In this blog, we’ll explore what RMDs are, why they matter, and how you can incorporate them into your year-end financial strategy. Here’s what you need to know about RMDs and how to manage them effectively.

What Are Required Minimum Distributions (RMDs)?

RMDs are the minimum amounts the IRS mandates you withdraw annually from your tax-deferred retirement accounts once you reach a certain age. RMDs must be taken from accounts including 401(k)s, Simplified Employee Pension (SEP) IRAs, traditional IRAs, and SIMPLE IRAs. These withdrawals ensure that retirement savings are eventually taxed, as contributions and growth in these accounts were initially tax-deferred.

Key Points

As of 2023, RMDs begin at age 73 for individuals who turn 72 after January 1, 2023, due to changes in the SECURE Act 2.0. For those born before this date, RMDs may have started at age 72 or earlier.
For most retirement account holders, December 31st is the deadline to take RMDs for the current year. The exception is for individuals taking their first RMD (usually the year they turn 73). In this case, the first RMD can be delayed until April 1st of the following year. However, delaying means you'll take two RMDs in the same year, potentially increasing your tax liability.

Roth IRAs, in contrast to Traditional IRAs, do not require RMDs during the account holder's lifetime, offering flexibility in tax planning.

Tax Implications of RMDs

Because RMDs are considered taxable income, they can impact your overall tax liability. Withdrawals are taxed at your ordinary income tax rate, and depending on the size of your RMDs, they might push you into a higher tax bracket. It is important to consider aligning RMDs with other taxable events to avoid crossing thresholds for Medicare premium increases or Social Security taxation.

What Happens If You Miss an RMD?

The IRS imposes a steep penalty for failing to take your RMD or withdrawing less than required. As of 2023, the penalty is 25% of the amount not withdrawn, though this can be reduced to 10% if corrected promptly. To avoid this, ensure you stay informed of your RMD deadlines and work with a trusted financial advisor.

Strategies to Manage RMDs

Proactive planning can help you mitigate the tax impact of RMDs while aligning withdrawals with your broader financial goals. Here are some strategies to consider:

1. Roth Conversions

Converting a portion of your Traditional IRA to a Roth IRA before RMDs begin can reduce the size of future RMDs. This strategy involves paying taxes on the converted amount upfront but can lead to tax-free growth and distributions later.

2. Qualified Charitable Distributions (QCDs)

If you’re charitably inclined, a QCD allows you to satisfy your RMD requirements by donating directly to a qualified charity. QCDs are excluded from taxable income, making them a tax-efficient way to give back.

3. Consider Timing

RMDs do not need to be taken in a lump sum towards the end of the year. Spreading withdrawals across the year, rather than taking a lump sum, can help manage cash flow and potentially reduce tax liabilities.

Year-end is an excellent time to review your overall cash flow needs. If you don’t require the RMD funds for living expenses, consider how you’ll allocate or reinvest them to align with your financial goals:

Reinvesting RMDs in a taxable brokerage account.
Using the funds to pay for Roth IRA conversions.
Gifting funds to family or beneficiaries as part of estate planning.

4. Aggregate RMDs

If you have multiple IRAs, you can aggregate RMDs and withdraw the total amount from a single account, simplifying the process.

What Happens If You Miss an RMD?

Conclusion

As the year comes to a close, RMDs should be a priority in your financial planning checklist. Whether you’re managing them for the first time or have taken them for years, careful timing and coordination with your overall financial strategy can help you optimize your tax strategy and maximize your wealth. Working with a financial advisor ensures you’re not only meeting IRS requirements but also taking advantage of planning opportunities unique to your situation.

Ready to Plan for Your RMDs?

At Chicago Partners, we specialize in personalized strategies for retirement account holders. Contact us today to schedule a consultation and ensure your retirement strategy is aligned with your financial future.

Sources:

Fidelity. (2024). "What's a qualified charitable distribution (QCD)?". Retrieved from https://www.fidelity.com/retirement-ira/required-minimum-distributions-qcds#:~:text=What's%20a%20qualified%20charitable%20distribution,as%20certain%20rules%20are%20met.
Investopedia. (December 3, 2024). "How Retirement Account Withdrawals Affect Your Tax Bracket". Retrieved from https://www.investopedia.com/ask/answers/030316/do-retirement-account-withdrawals-affect-tax-brackets.asp#:~:text=These%20withdrawals%20are%20considered%20taxable,higher%20tax%20bracket%20in%20retirement.
Investopedia. (November 11, 2024). "Roth IRA Conversion: How It Works, Plus the Pros and Cons". Retrieved from https://www.investopedia.com/articles/financial-advisors/102715/pros-and-cons-creating-backdoor-roth-ira.asp.
IRS. (August 19, 2024). "Retirement plan and IRA required minimum distributions FAQs". Retrieved from https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs#:~:text=Required%20minimum%20distributions%20(RMDs)%20are,Dec.%2031%2C%202022.

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