Required Minimum Distributions (RMDs) tend to be a concern that never reach the forefront of our minds… until we turn 70 years old. At that point, the google searches start, the interpretations of tax codes are attempted, and the anxiety sets in.
From a fiduciary standpoint, we believe these burdens can be easily overcome. Instead of waiting until it happens, there are many proactive strategies that can lower your burden and help you keep control of your RMD destiny. This article will attempt to give you a quick deep dive into what RMDs are, how they can affect you, and how you can control them before they start to control you.
Why Are RMDs Necessary?
For the majority of your working life, the IRS has allowed your pretax accounts (401k, 403b, and IRA) to grow tax deferred, meaning you have not paid income tax on these funds, and, what’s more, your contributions have reduced your taxable income for the calendar years in which you were contributing. What a great benefit!
However, instead of dealing with all of the taxes in the estate after you pass away and having paid little income tax in retirement, the IRS would like to start getting those deferred taxes back earlier and over time. This led to the creation of the Tax Reform Act of 1986, which requires taxpayers to begin taking annual distributions from their pretax retirement accounts.
When Do I Have To Start Taking My RMD?
A Required Minimum Distribution is a mandatory distribution from a traditional, pretax IRA when an individual reaches the age of 70.5. The first year you turn 70.5, you have the option to wait until April 15th of the following calendar year to take out your RMD for the previous year, but every year after that it must be withdrawn by December 31st.
At first glance, it may sound nice to wait the first year until the next spring to distribute your RMD. However, since you have to withdraw your RMD by that second year’s end, if you wait, you will have two RMD distributions that year: one for the previous year and the second for the current year. It’s a good idea to stay on top of your RMD by taking it out each year by December 31st, so you only have one per year. If you turn 70.5 by December 31st of the calendar year, that’s how you know you need an RMD for that year.
How Are RMDs Calculated?
RMDs are calculated by taking your age on December 31st of the current year and entering your pretax IRA account balance as of December 31st of the previous year. This is often called the Fair Market Value. Using an IRS distribution table, you can calculate how much you need to withdraw for that calendar year. The percentage will decrease slightly each year as you age.
Note, the IRS does not mandate you withhold federal and state taxes at the time of the distribution, but many individuals opt to do this. You can opt to pay the taxes the next spring if you’d like. The IRS wants to see the funds are moved out of a pretax account into a taxable account, triggering the taxable event of the distribution for that year.
Do I Have To Take The RMD Out Of Each Account?
Luckily, the IRS allows the aggregate, or combined total of the December 31st balance of your IRAs, to be taken out of any pretax account and not each individual account separately, unless that account is a 401k. You will still get mail from each company notifying you of the RMD needed. By working with a fiduciary financial advisor, you can determine the best source to withdraw the funds each year.
How Do I Lower My RMD Burden?
One of the biggest tax saving strategies retirees can take advantage of is called the IRA to Roth conversion. Depending on your time frame and IRA to non-qualified asset ratio, each year, you can slowly convert some of your IRA assets to your Roth assets. One of the more common methods is called the back-door IRA to Roth conversion.
By teaming up with a CPA and a math-based fiduciary retirement planning firm, you may be able to coordinate the effort and completely eliminate RMDs altogether. These proactive strategies are no simple task, but with the right help, and willingness to be proactive, you may be able to significantly decrease your future tax burden.
Who Can Help Me With This Process?
Choosing to work with a fiduciary retirement planner, who can help you calculate and distribute these funds in the most effective way for your specific retirement goals, can be well worth the visit. Make sure they are series 65 licensed, work for a Registered Investment Advisory (RIA), and are independent. During these conversions, it is important to work with your CPA, so all efforts are being coordinated effectively and appropriately.