Take Those RMDs

For the past couple of weeks we’ve looked at important year-end questions. Another timely one might be, “Have I taken my RMD yet?”. We’ll get into that but first let’s put things into perspective.

Saving and investing for retirement is all about the tradeoffs that come with delayed gratification. Money accumulated for the future needs to be saved today, years or even decades before spending it. Then you have to put your hard-earned money at risk to reap the rewards of time in the markets and compound interest. Neither are much fun in the present, but we balance this with the knowledge, and perhaps faith, that we’ll come out ahead later by doing so.

The government helps with this, too. Decades ago the IRS started allowing taxpayers to fund Individual Retirement Accounts (IRAs). At the time the novel idea was to let savers contribute money that could then be deducted from their taxable income. This was a great motivator to get people saving.

But, as they say, there’s no free lunch. The tax break was the carrot, and the stick was that the government would eventually come to collect. And they wouldn’t wait forever. Savers had to start withdrawing and paying tax on a Required Minimum Distribution (RMD) from the account by age 70 ½, whether they needed the money or not. The starting age was recently bumped to 72, but the concept is the same.

Then the stick was sharpened by another tradeoff. Not only would the government collect tax on the original contributions, but on every dollar of growth as well. The government would forgo tax on, say, the $1,500 saved in 1975 (the max amount in the first year for contributions) and wait to tax perhaps $55,000 of value in the future. Talk about delayed gratification!

RMDs aren’t that relevant for many retirees because they’re already withdrawing more than the required minimum for living expenses. But a good many others don’t necessarily need the money to live on, or at least not right now, and get annoyed by feeling forced to withdraw money just to pay tax on it.

Let’s discuss some of the RMD particulars at a high level.

As I mentioned a moment ago, the starting age for RMDs is now 72. This means the account owner must take a distribution from their IRA (not a Roth IRA, just a “Traditional” or “Rollover IRA”) by the end of the calendar year in which they attain that age. Then the process is repeated each following year.

Fortunately, your brokerage firm calculates your RMD, so you don’t need to worry about the math. That said, the mechanics aren’t especially complicated. The value of your account at the end of the prior year is divided by a life expectancy factor found on a table published by the IRS. The result is your RMD for the current year.

The government doesn’t care if you take your RMD all at once, on the first or last day of the year, or once a week for that matter. All the tax folks care about is that you’ve at least withdrawn your RMD by December 31^st.

There’s a special pass for the first year’s distribution that allows you to take it by April 1^st of the year following, but then that year you’d need to take two, one for the prior year and one for the current and pay tax on both. You’d only want to do this if 1) you forgot during the calendar year and have to play catch up, or 2) you’re expecting lower taxable income during the year you turn 73. Otherwise, keep it simple and focus on year-end as your deadline.

And there’s no way to get out of paying tax on the distributions. That is unless you’re willing to give the money away. There’s a rule allowing folks who are at least 70.5 (that’s still at the prior age – don’t ask me why) to give their RMD, up to $100,000 per year, to charity. It can be one big gift that year or lots of little ones, the government doesn’t really care. What they focus on is that the money goes directly to charity. It can’t even get within a mile of your checking account.

There are some other things to remember, such as you can combine all of your IRAs and take the total RMD from just one account, but you can’t combine with your spouse. And the rules are a little different if your spouse is more than ten years younger. Also, your brokerage firm can withhold taxes from your RMD, but it’s not required. If you do withhold, which is probably the simplest thing to do, it could take the place of making estimated tax payments.

And you’ll want to make sure not to forget about taking your RMD. The penalty is 50% plus you’ll have to add the one you missed to the then current year’s RMD and pay tax on both in the same year.

Beyond that, we haven’t discussed IRAs that you might have inherited. Spouses get to treat IRAs they’ve inherited as their own, but others have a different set of rules to conform to. Oh, the never-ending joys of the tax code!

Have questions? Ask me. I can help.