Retirement accounts, such as traditional IRAs and workplace 401(k) plans, are great ways for many to save for their post-work years.
These tax-deferred plans offer a variety of benefits, ranging from reduced taxes on work earnings to a potential tax deduction for some IRA owners to the added Saver's Tax credit for eligible filers.
But these tax-deferred retirement accounts also come with a big drawback. At some point the Internal Revenue Service demands you take out at least some of the retirement funds.
The reason is obvious. Uncle Sam is tired of waiting for his tax cut. To get it, the IRS uses required minimum distributions, or RMDs.
The return of RMDs: RMDs were waived in 2020, because of (what else?) the COVID-19 pandemic.
Specifically, the Coronavirus Aid, Relief and Economic Security (CARES) Act that became law back in March of that year, gave older retirement plan owners that year off.
But the required withdrawals from tax-deferred retirement plans returned in this year. That means some account owners must take RMDs by Dec. 31, 2021.
Age change complications: Your age triggers when you must start RMDs from your affected retirement account. But since we're talking tax law, there's more involved than just the day each year that you blow out birthday cake candles.
If your RMD age is in the first half of the year, you must take your first mandated withdrawal by the end of the year. But if your RMD trigger age is in the second half of the year, you get four extra months, until April 1 of the next year.
The RMD age used to be 70½ years old. However, the Setting Every Community Up for Security Enhancement (SECURE) Act upped the RMD age to 72.
The age change means that —
- individuals who turned 70½ in 2019, (their 70th birthday was June 30, 2019, or earlier) did not have an RMD due for 2020, but they now must take one by Dec. 31, 2021; and
- individuals who turned 72 in 2021 (and their 70th birthday was July 1, 2019, or later) have their first RMD due by April 1, 2022.
Timing could affect tax bills: While the option to delay your first RMD might be appealing, especially if you have a lot of other year-end financial obligations, make sure you understand the implications.
When you postpone that first RMD until the next year, that means you'll have to take two retirement distributions that year. The April 1 is for the prior tax year, and the Dec. 31 is for the current year, with the second one due by Dec. 31 for the current year.
Taking two distributions in the same tax year could increase your taxable income, and possibly mean your Social Security benefits also are taxed or taxed more.
Any time annual withdrawals: After you reach your RMD trigger age and make it past the first one, regardless of whether you take in in the actual year it applies or postpone it into the next, then for each subsequent year you must take an RMD by Dec. 31.
You don't, however, have to wait until the very end of the year. When your RMDs kick in, you can take out the money any time during the applicable year.
Also, while you must take the minimum amount, you can take out more if you wish.
Note, too, that even though your retirement money might be in an investment account, the withdrawals are not taxed at the generally more favorable capital gains tax rates. Distributions from tax-deferred retirement plans are taxed at ordinary tax rates.
Affected accounts: There are a lot of retirement accounts and a lot of tax rules for them. As for RMDs, the withdrawals are based on money in tax-deferred accounts.
- traditional Individual Retirement Arrangements (IRAs);
- traditional Simplified Employee Pension (SEP) IRAs;
- Savings Incentive Match Plans for Employees (SIMPLE) IRAs; and
- other various workplace retirement plans, including 401(k), Roth 401(k), 403(b) and 457(b) plans.
Roth IRAs, however, are not subject to RMDs. Contributions to these accounts were made after the owner paid taxes on it, so the U.S. Treasury already got its due tax. That means that you, not the federal government, can decide when to take, or not, your Roth account distributions.
Determining the amount: OK, so just how much is your RMD? Again, it depends.
RMDs are determined by your age and the value of your affected retirement account(s) at the end of the previous tax year. You should get each year a Form 5498, IRA Contribution Information, or IRS-accepted substitute document that report your account's value.
♦♦♦ See more about other tax forms at Tax Forms Fiesta! ♦♦♦
That's then used in conjunction with a life expectancy form, that calculates a percentage of your retirement account that must be distributed. Most account owners use the Uniform Lifetime Table III in Publication 590-B, Distributions from IRAs.
You can read more about changes coming in 2022 to life expectancy and RMD calculations, as well as check out the current version of the commonly-used uniform lifetime table in this earlier post. The IRS also has online worksheets that help you figure your RMD.
If you have multiple retirement accounts subject to RMDs, you must calculate the RMD separately for each. However, if your various retirement plans are separate traditional IRAs, you can choose to withdraw the total amount from one or each of them.
The rule is different for workplace plans subject to RMDs. If you have, for example, several 401(k) plans, required distributions from these accounts must be taken separately from each plan.
Withdraw or pay more: No one wants to spend retirement messing with taxes, but don't blow off RMDs.
If you don't take a required distribution, or don't withdraw, you could face a 50 percent excise tax on the amount you have taken. You read that right. Fifty, five-O, percent.
So take your RMD and simply put the funds back into another savings vehicle.
Or donate your RMD: If you don't need the RMD amount to cover your Golden Years expenses, look into donating your distribution. You can make a qualified charitable distribution, or QCD. This is a direct transfer of funds from your IRA, payable directly to a qualified charity.
Up to $100,000 in retirement account amounts donated as QCDs can be counted toward satisfying your annual RMD.
You won't get an itemized tax deduction for the charitable gift. But you keep Uncle Sam happy (or at least you don't irk him), while escaping tax on the amount of money he made you withdraw from your retirement plans.
You also might find these items of interest:
- 7 tax breaks for older taxpayers
- Retirement, pension plan inflation adjustments for 2022
- IRS updates life expectancy tables that will determine 2022 RMDs
- Bill to save Social Security would increase payroll tax wage base, change annual COLA calculation