Required Minimum Distribution - RMD
The RMD is the amount the IRS requires you withdraw from your IRA each year. The logic is this: you received a tax deduction for putting money into your 401(k)/IRA and you have avoided paying taxes while it grows. Eventually you need to take it out. To make sure this happens, they invented the RMD. The calculation for how much is a complicated chart; when you would start the withdrawals used to be easy. Now, not so much. The rules for required minimum distributions (RMDs) recently changed when the SECURE Act was passed in 2019. This increased the age when you need to start taking RMDs to 72 but also subjected newly inherited IRA accounts (as a result of death) to a ‘10-year rule’ that requires the account to be emptied within 10 years of the death of the original owner, with some exceptions. This could be done immediately, spread equally, or mostly weighted towards the back portion of the 10 years. This was messy, but everybody was starting to get it figured out. Then:
Potential Change
In early 2022, the IRS issued proposed regulations that detailed its interpretation of the 10-year rule. Under this interpretation, some beneficiaries could be required to take annual required distributions in addition to the 10-year distribution requirement, in which the account must be depleted at the end of 10 years. This could be really messy, and we are watching this proposed change. It would eliminate several of the planning opportunities currently available but, like everything out of Washington D.C., who knows if this change will ever happen. So for now, let’s focus on the laws as they currently exist:
The Basics:
Who must take RMDs?
In general, individuals who own a traditional IRA, or participate in a qualified retirement like a 401(k), must start minimum distributions from these accounts at age 72 (70.5 if you were born before 7/1/1949).
When do you have to take your first RMD?
No later than April 1 of the year after you turn 72. For example, if you turn 72 on August 1, 2022, you have until April 1, 2023, to take your first RMD.
What accounts are subject to RMDs?
Traditional IRAs, Inherited IRAs, SEP IRAs, SIMPLE IRAs, and most qualified retirement plans like 401(k)s, 403(b)s, etc. Remember, employer retirement accounts (401(k)s and 403(b)s generally turn into IRAs once you retire. ROTH IRAs are not subject to RMDs during the owner’s lifetime.
What if you forget to take your RMD?
Of course, a 50% tax penalty applies.
At Death
When you pass away, the RMD rules dictate how quickly your IRA or retirement account will need to be distributed to beneficiaries.
Spousal Exception
The 10-year rule generally does not come in to play until the death of you and your spouse. Your spouse’s RMD schedule applies to any IRA they would inherit from you.
How do distributions to non-spouses work?
If you pass away before starting RMDs from your IRA or qualified retirement account, the account must be fully distributed before or within 10 years of your death. If you pass away after starting RMDs, the account must continue annual distributions based on the designated beneficiary’s remaining life expectancy for the first nine years after your death; however, by the tenth year, the remainder of the account must be distributed.
Other Exceptions
They give you some relief from RMD rules if you leave your IRA to a chronically ill individual or a sibling/family member within five years of your age. In these situations, and a few others, these types of eligible designated beneficiaries will be based on the greater of a) what would have been your remaining life expectancy, or b) the beneficiary’s remaining life expectancy.
Trusts
Trusts do not impact these distribution rules at all unless your trust is out of date or is used improperly by the financial advisor following your passing.
The Long and Short
The RMD rules are incredibly complicated: lots of planning goes into how to take them while you are alive and how your beneficiaries should take them after you are gone. If you are confused about the interplay between your Trust and IRA, or you are confused about how your RMD works, give us a call and schedule a review. We can clear up any confusion, go over your planning options, navigate the tax ramifications of those options, and build a big picture plan for leaving a legacy.