Don't Mess With Taxes

If you're in your seventies, it's time to start preparing for nest egg withdrawals, some of which are required by federal tax law.

A couple of new retirement laws over the last few years, collectively known as the Setting Every Community Up for Retirement Enhancement (SECURE) Acts, have made a lot of changes to retirement plans and the collection of associated taxes.

One revision was the bumping up the date when most older owners of tax-deferred retirement accounts must start taking some money from these savings. Starting in 2023, required minimum distributions, known by the acronym RMDs, don't kick in until you turn 73.

But if you celebrated your 72nd birthday last year, and didn't take your first RMD by Dec. 31, 2022, you must withdraw the specified amount by April 1. That's less than two weeks away.

No fooling.

Saving temporarily out of tax reach: Millions of people save for retirement via tax-deferred plans, such as traditional IRAs and regular 401(k)s offered by their employers. Other RMD-affected accounts are workplace 403(b) or 457(b) plans, and traditional SEP or SIMPLE IRA accounts.

Contributions to all these savings are made with pre-tax money. The longer you're able to leave your retirement savings untouched, the more your contributions and their earnings will grow, tax-deferred.

But Uncle Sam won't wait forever for his cut. Hence, the RMD rule was created. It sets a specific amount, per account owner, that must be taken once the saver reaches the trigger birthday year.

When it comes to the first RMD, tax law gives account holders extra time to take it. They have until April 1 of the year after which they reach the distribution age. In all following years, RMDs must be taken by Dec. 31.

Calculating your RMD: Your annual RMD is based on your tax-deferred account values at the end of the previous year and your age.

The Internal Revenue Service, naturally, helps here. It has tables that use life expectancy data, and which were updated for the 2022 tax year, to help you calculate your RMD each year.

The first thing is to find your tax-deferred retirement account's year-end statement. This will show you the dollar amount with which you must work. Take that Dec. 31 value and divide it by the years shown for your age in the appropriate IRS table.

Here's a simple example:

Janet turned 72 in June 2022. Her traditional IRA was worth $100,000 at the end of 2021. Janet uses the IRS' Uniform Lifetime table, which shows a life-expectancy distribution period for 72-year-olds of 27.4 years. She divides her $100,000 account value by 27.4 to learn that she must take $3,650 (rounded up) from her IRA.

That, as the RMD name indicates, is the minimum Janet must take out of her IRA. She can take more if she needs or wishes (more on this in a minute).

Note, too, that even if your nest egg is in an investment vehicle rather than a basic savings account, tax on the RMDs will be at your ordinary income tax rate, which now has a top 37 percent rate, not the usually lower (0, 15, or 20 percent) capital gains tax rate.

Different account owners, multiple tables: Our example septuagenarian traditional IRA owner Janet used the Uniform Lifetime, or Table III, found in Appendix B of IRS Publication 590. It is the one used by most.

The Uniform Lifetime table is for tax-deferred retirement account owners who are unmarried; married and whose spouses aren't more than 10 years younger; or married and whose spouses aren't the sole beneficiaries of their IRAs.

But there are many different retirement savers with different circumstances. So the IRS has two other life expectancy tables.

If your situation doesn't fall into the Uniform Lifetime table parameters, check out the Which Table Do You Use? section of IRS Publication 590. It will help you decide which of the three tables to use, and has links to those tables.

Multiple accounts, more calculations: As the hubby and I have gotten older, we've simplified our investments. We've consolidated our various nest eggs, and now each of us has just one tax-deferred retirement plan on which we'll have to figure our separate RMDs.

If you prefer diversity of tax-deferred retirement plans, get ready to do multiple RMD calculations.

You must figure the RMD separately for each traditional IRA you own. You can, however, withdraw the total amount due from one or more of the IRAs.

Similarly, if you have more than one 403(b), you must calculate the RMD separately for each. Here you also can take the total amount from one or more of the 403(b) plans.

However, RMDs required from other types of retirement plans, such as 401(k) and 457(b) plans, must be taken separately from each of those plan accounts.

More is allowed (and taxed): While Janet has to take $3,650 from her traditional IRA, as mentioned earlier, she's free to take more.

That's fine with the IRS. It would love to get even more of Janet's (and everyone's) deferred tax payments for which it's been waiting.

These more-than-minimum amounts, however, won't change your annual RMD amounts.

If any year you receive more than that year's RMD, you won't receive credit for the additional amount when determining required withdrawals for future years. You don't get to carry the excess RMD forward to a future tax year.

Withdraw RMD or pay a penalty: If you reach your RMD age, but don't need your retirement plan money to cover current living expenses, you might be tempted to ignore the withdrawal mandate. Don't.

Tax law says you'll pay a penalty for not taking an RMD.

The good news is that the SECURE Act 2.0, enacted on Dec. 29, 2022, cut the penalty in half. The bad news is that it's still pretty steep.

Previously, you faced a 50 percent excise tax on the RMD amount you were supposed to take. It's now 25 percent.

That penalty tax could be cut to 10 percent if you correct your missed distribution within two years. Do that by filing Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts (form excerpt image below).

See more tax forms and more about them at 2022's Talking Tax Forms and Tax Forms 2023.

The penalty may be waived if you can show that the RMD shortfall was because of reasonable error and that you are taking realistic steps to remedy the shortfall. In this case, file Form 5329 and attach a letter of explanation. The form's instructions (or your tax advisor) have more on how to handle missed RMDs.

Give your RMD instead: There is another option if you don't need your RMD money. You can give it to an IRS-approved charity. This will ensure you meet your RMD, but you won't owe tax on the donated amount.

Just make sure you follow the donation rules. You can't take the RMD yourself, then write a check in that amount to the nonprofit. Since you took the money, it's still taxable income on your tax return.

Instead, work with your retirement account's manager and give the amount as a qualified charitable distribution, or QCD. Charities also are well-aware of this option and your favorite also probably has guidelines to help you make a QCD.

With this philanthropic option, your RMD amount is transferred per your instructions directly to your IRS-authorized charity. You don't ever get the money, so while the RMD is taken from your tax-deferred retirement account and counts as you meeting your obligation, the dollars don't count as taxable income to you.

Currently, QCDs are capped at $100,000 per year. That should be plenty for most who are facing an RMD on April 1 or Dec. 31.

The QCD limit will be adjusted annually for inflation, per SECURE 2.0, starting in 2024.

Other RMD tax and financial matters: Finally, if you are taking your first RMD by April 1, remember that the money counts as income for the 2023 tax year. Note, too, that you also must take your 2023 tax year RMD by this Dec. 31.

That means you'll owe tax on both RMDs in the same year. Be sure to factor the double RMD amounts into your 2023 tax bill planning.

That planning also includes, for most taxpayers, state taxes. Your RMD could push you into a higher federal and, if your state has a progressive tax system, state tax brackets.

RMD income also could affect your federal retirement benefits. More income from your retirement plan could mean a larger portion of your Social Security benefits is subject to federal taxation.

Higher-income Medicare enrollees also could see their Part B (doctors' visits and outpatient tests) and Part D (prescription drugs) premiums hiked due to income-related monthly adjustment amount, or IRMAA.

IRMAA is determined by income from your income tax returns two years prior. This means that your 2023 income tax return will be used to determine your 2025 IRMAA exposure. So, your RMD amount this year could cost you in 2025. Potential IRMAA also could be another reason to consider a QCD, which will keep your RMD out of your taxable income tally.

The first consideration, though, is to know when you must take your RMD, and meet that deadline. Especially if it's your first one coming due on April 1.

You also might find these items of interest:

• The tax-saving ABCs of RMDs and QCDs
• IRS updates life expectancy tables that determine RMDs
• Last-minute tips for those facing Dec. 31, 2022, retirement plan RMDs
• Retirement savings' values have dropped, but some trends are positive

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