Don't Mess With Taxes

Did you turn 73 last year? Belated happy birthday wishes.

Now here's an important tax question about that septuagenarian celebration. Did you take your first required minimum distribution (RMD) from your tax-deferred retirement funds by the end of 2023?

If the answer is no, then you've got to withdraw that mandated amount by next Monday, April 1.

No fooling.

Miss that RMD deadline date, and you'll owe Uncle Sam more money than just the tax due on your withdrawal amount.

Ending tax deferral days: The Internal Revenue Code offers myriad tax benefits for retirement savers. Several of them provide tax-deferred growth of contributions.

These retirement plans include traditional IRAs, regular 401(k)s offered by employers, 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, out of reach of the Internal Revenue Service.

But Uncle Sam won't wait forever for his cut, so the RMD rule was created. It sets a specific amount, taking into account the savings plan amount(s) and owner's life expectancy, that must be taken once the saver reaches the trigger birthday year.

Starting in 2023, the RMD age is 73. It increases to age 75 in 2033.

The RMD amount must be taken by Dec. 31 of each year, but the law provides a few month's leeway for the first required withdrawal. In that initial RMD birthday year, you can delay your first savings distribution until April 1 of the following year.

So birthday number 73 celebrants in 2023 have until April 1, 2024, to make that first RMD. In all subsequent years, RMDs must be taken by Dec. 31.

And if your RMDs kicked in when you were relatively younger, for example, ages 70½ or 72 under prior mandated distribution laws, you still have to take out the annual amounts by the end of each tax year.

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 IRS provides tables that use life expectancy data 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 73 in June 2022. Her traditional IRA was worth $100,000 at the end of 2022. Janet uses the IRS' Uniform Lifetime table, which shows a life-expectancy distribution period for 73-year-olds of 26.5 years. She divides her $100,000 account value by 26.5 to learn that she must take $3,774 (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: The RMD applies to all your tax-deferred retirement plans. So if you have multiple such nest egg vehicles, you'll have to make 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.

And note that you can delay taking RMDs past age 73, but only from your current employer's retirement plan if you're still working. You must, however, still take any IRA-related RMD.

More is allowed (and taxed): While Janet, as mentioned in the earlier example, has to take $3,774 from her traditional IRA, she's free to take more.

That's fine with the IRS. It would love to get it's piece of even more of Janet's (and everyone's) tax-deferred savings than what it collects on minimum amounts taken out by the annual RMD deadline.

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

You don't get any credit for the additional RMD amount you take when determining required withdrawals for future years. Neither can you 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 second Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law on Dec. 29, 2022, cut the missed RMD 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 Tax Forms 2024.

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.

Donate 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. In some cases, you are sent a check from your savings with the RMD amount made payable to your chosen charity so that you can forward the gift yourself.

The bottom line is that you don't ever get access to the money. While the RMD is taken from your tax-deferred retirement plan and counts as you meeting your distribution 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 the 2022 SECURE Act, 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 2024 tax year. Note, too, that you also must take your 2024 tax year RMD by this Dec. 31. The first-year RMD extension is the only added time you'll get.

That means you'll owe tax on both RMDs, the April 1 and withdrawal due by Dec. 31, in the same year. Be sure to factor the double RMD amounts into your 2024 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 2024 income tax return will be used to determine your 2026 IRMAA exposure. So, your RMD amount this year could cost you in two years. 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:

• 7 tax breaks for older taxpayers
• The tax-saving ABCs of RMDs and QCDs
• Tax-favored retirement savings get cost-of-living 2024 boost

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