Don't Mess With Taxes

Most of these birthday celebrants at an Austin-area senior citizens' center are enjoying the shared festivities. Maybe the man on the right is worried about his upcoming RMD. (Photo by Kay Bell)

Did you celebrate your 73rd birthday last year? Congratulations and belated best wishes.

The Internal Revenue Service also applauds your milestone, but partly for selfish reasons. Individuals who have certain tax-deferred retirement plans must start withdrawing some of those funds and pay tax due on the amounts once they turn 73.

These required minimum distributions (RMDs) are annual. But you can delay your first withdrawal until April 1 of the year after you reach age 73.

If that’s you, then make sure you meet the deadline, which is now just a week away. Miss it and you’ll owe Uncle Sam more money than just the tax due on your withdrawal amount.

No fooling.

Ending tax deferral days: Tax-deferred accounts are one type of retirement vehicles available under the Internal Revenue Code. The plans allow taxpayers, and in some cases their employers, to contribute pre-tax money that, along with the associated earnings, are not taxed until withdrawn, generally during the account owner's retirement years.

Accounts that are subject to RMDs include traditional IRAs, regular 401(k)s offered by employers, workplace 403(b) or 457(b) plans, and traditional SEP or SIMPLE IRA accounts.

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 It sets a specific amount, considering the savings plan amount(s) and owner's life expectancy, that must be withdrawn once the saver reaches the trigger birthday year.

Retirement account changes in the two Setting Every Community Up for Retirement Enhancement (SECURE) Acts tweak those birthdays. In 2023, the RMD age increased to 73. It goes to age 75 in 2033.

The RMD amount must be taken by Dec. 31 of each year. However, tax law provides a few month's leeway for the first required withdrawal. In that initial RMD birthday year, septuagenarians can delay their first retirement account distribution until April 1 of the following year.

So, birthday number 73 celebrants in 2024 have until this quickly approaching April 1 to take their first RMD. In all subsequent years, they must take RMDs by Dec. 31.

And if your RMDs kicked in under prior account distribution tax laws when trigger ages were 70½ or 72, 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 simplified example:

Janet turned 73 in June 2024. Her traditional IRA was worth $100,000 at the end of last year. 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 the tax on RMDs is at your ordinary income tax rate, which now has a top 37 percent rate.

Some people mistakenly think their RMDs are subject to the generally lower capital gains tax rates of 0, 15, or 20 percent, because their nest eggs are in an investment vehicle, rather than a basic savings account. Sorry, that’s a wrong assumption.

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 accounts, 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.

In most cases, trustees of retirement plans will alert affected account owners of the deadline. Most also will tell you how much you must take to comply with RMD rules. They also can help you set up automatic RMDs so you don’t miss the annual deadline

The RMD amount will typically appear on Form 5498, IRA Contribution Information, in Box 12b. For a 2024 distribution due by April 1, 2025, the amount is shown on the 2023 Form 5498, usually issued early in 2024.

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 and Tax Forms 2025.

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.

For the 2025 tax year, you can make a QCD of up to $108,000. The special retirement gift limit is adjusted annually for inflation.

Other RMD tax and financial matters: Finally, remember how relieved you were when you found out last year that you could push your first RMD until this April? It really helped with your cashflow, and kept your 2024 tax liability from escalating.

Now, however, you’re going to face double RMDs and associated taxes.

Even though your April 1 RMD is for the 2024 tax year, you didn’t receive it until this year. That means you must count it on your 2025 return you file next year.

Then you must take your 2025 RMD by this Dec. 31. That’s another payout on which taxes must be paid.

So, for this year, you will owe tax on two RMDs instead of the usual one per year. Be sure to factor the double RMD amounts into your 2025 tax bill planning, perhaps adjusting your estimated tax amounts for this year to cover the added taxable distributions.

RMD tax 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 bracket.

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 2025 income tax return will be used to determine your 2027 IRMAA exposure. So, your RMD amount this year also 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 next week, on April 1.

You also might find these items of interest:

• Need free tax help? VITA or TCE volunteers could be the answer
• The current federal tax on Social Security benefits and efforts to end it
• Changes in 2025 to tax-favored workplace retirement accounts can help you save more

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