The Atomic Retirement
The Atomic Retirement
6. What are Required Minimum Distributions (RMDs)?
What are Required Minimum Distributions (RMDs)? That's what I'm talking about on this episode of The Atomic Retirement Podcast.
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Ryan Kilkenny 0:00
Hi everyone and welcome to The Atomic Retirement. I'm your host, Ryan Kilkenny, the founder of Atomic Planning, an independent, veteran-owned, fee-only financial planning firm bringing tax and retirement planning to families over age 50. Atomic Planning is a virtual financial planning practice in Kansas City, serving families from coast to coast, from California to North Carolina. Thanks for joining me, and welcome to episode six of The Atomic Retirement.
Ryan Kilkenny 0:29
Today we're talking about required minimum distributions or RMDs. And this is an especially timely topic because April 1 is the RMD deadline for anybody that turned 72 during the last six months of 2021, so anybody that turned 72 between July 1 and December 31 of 2021. More on that in a bit.
Ryan Kilkenny 0:52
What is a required minimum distribution? A required minimum distribution is the minimum amount the IRS says some people have to withdrawal from their retirement accounts each year. That's right. You can't keep money in your retirement accounts forever. At a certain point, or because of a triggering event, the government will require you to begin taking withdrawals from your retirement accounts. Think about it. You and your employer have set aside money that's never been taxed. It has grown tax deferred. The government wants to collect income taxes, and they've decided that 72 is the magic age to start doing so.
Ryan Kilkenny 1:33
RMDs used to actually start when you turned age 70 1/2. Now, I don't know about you, but my half birthday isn't something that is marked on my calendar. Facebook doesn't announce it to the world. My mom doesn't call to sing, and it's just not something that I celebrate. And now that I'm thinking about it, my 35 1/2 birthday actually came and went last week without anybody's notice, including my own. Half birthdays are a bit odd to base rules around, especially ones with 50% penalties.
Ryan Kilkenny 2:06
So in 2019, the government made a change and said if your 70th birthday falls on or after July 1, 2019, you can delay RMDs until you turn 72. That makes last year a little bit weird because people that turned 72 in the first half of 2021 fall under the old 70 1/2 rule, and have been required to take RMDs since 2019, although nobody had to take RMDs in 2020 because of the Coronavirus pandemic.
Ryan Kilkenny 2:40
People that turned 72 in the second half of 2021 must complete their first RMD by April 1 of 2022. And so going forward, this should become a little bit less confusing, as RMDs will apply to everyone when they turn 72. Which means your very first RMD will be due by April 1 of the year after you turn 72.
Ryan Kilkenny 3:05
So for example, if you turn 72 This year, your very first RMD will be due by April 1 of next year. And after that, your annual RMD will be due by December 31 every year. And so here's the thing. Let's take our crowd that turns 72 in the second half of 2021. Their 2021 RMD is due by April 1 of this year. Perhaps they took it last year, but if not, it means that they must take last year's RMD by April 1, and this year's RMD is also due by December 31. That's right. That means that they will have two RMDs due in calendar year 2022.
Ryan Kilkenny 3:57
So what accounts have RMDs? Okay, listen up. The following accounts have RMDs: traditional IRAs, SEP IRAs, SIMPLE IRAs, 401k plans, 403b plans, 457 plans, Thrift Savings Plans, profit-sharing plans, and other defined contribution plans. They all have RMDs.
Ryan Kilkenny 4:25
There are only two retirement accounts that do not have RMDs: Roth IRAs and health savings accounts (HSAs).
Ryan Kilkenny 4:35
So what about Roth 401k's Ryan? Do they have RMDs? Yes, Roth 401k's, or any employer Roth account, has an RMD. Again, the only two retirement accounts that do not have RMDs are Roth IRAs and HSAs.
Ryan Kilkenny 4:56
Now, how do you calculate your RMD? To calculate your RMD, you need to find your previous year end account balance and divide it by a number that corresponds to your age from one of the IRS' life expectancy and distribution period tables. Whatever that number is, is the number that you must withdraw from your account. Now, there are multiple tables, so it's critical to make sure that you select the right one for your situation.
Ryan Kilkenny 5:26
But let's run through an example using somebody that turned 72 in the second half of last year. Remember, they need to take their 2021 RMD by April 1 of 2022. And so to calculate their 2021 RMD, we need to locate their December 31, 2020 account balance, and divide it by the IRS table. We'll assume their situation require them to use the uniform lifetime table, and their December 31 IRA balance was $1 million. So in this scenario, someone 72 must divide their account balance by 27.4. That's the distribution period found in the IRS table. It's also how long the IRS would expect them to live. And so we divide 1 million by 27.4. and we come up with $36,497. That is their RMD for 2021 that must be withdrawn by April 1 of this year. And perhaps you see where I'm going with this. They have a second RMD due this year, their RMD for 2022. We'll assume their IRA ended December 31, 2021 also at a million dollars. But this time, we have to use the distribution period for someone age 73, which happens to be 26.5. And so every year you get older, the number that you divide your account balance by will get smaller. And that means that your withdrawals will get bigger. And so in this case, we divide a million dollars by 26.5 and we come up with $37,736. That is their RMD for 2022 that must be withdrawn by December 31. And so using this example, their 2021 and 2022 RMDs add up to $74,233.
Ryan Kilkenny 7:37
What happens if you fail to take your RMD or fail to take part of it? Well, you may have to pay 50% excise tax on the amount you fail to withdraw. And that's important to know, especially for folks that are new to RMDs or may have two RMDs this year. Excise taxes can have up to tens of thousands of dollars a year. And so this is one of the many reasons that I encourage people to keep their accounts organized, and to consolidate old employer retirement accounts. Having accounts all over the place just makes things more difficult to manage, and it increases the chances that you'll neglect to take an RMD. Another thing. RMDs don't just apply to people over 72. If you've inherited a retirement account, including a Roth IRA, you probably owe an RMD too. That's right.
Ryan Kilkenny 8:34
Roth IRAs don't have RMDs while you're living, but your heirs will have an RMD. The good news though, is that they shouldn't owe any income taxes on withdrawals from the Roth IRA.
Ryan Kilkenny 8:46
But, if you inherited a retirement account prior to 2020, you are probably allowed to stretch those withdrawals over the course of your life. That means that you'll use the appropriate IRS table for your situation. But, if you inherited a retirement account after January 1, 2020, new rules may apply. I'm paraphrasing the IRS website here, but a relatively new law, known as the secure act distinguishes between an eligible designated beneficiary and other beneficiaries who inherit an account or IRA.
Ryan Kilkenny 9:22
An eligible designated beneficiary includes a surviving spouse, a disabled individual, a chronically ill individual, a minor child or an individual who is not more than 10 years younger than the account owner. These eligible designated beneficiaries may take their distributions over their life expectancy. However, minor children must complete their distributions within 10 years of reaching age 18. Additionally, a surviving spouse may delay distributions until the account owner, the original account owner, would have turned 72, or when they themselves turn 72, whichever is later.
Ryan Kilkenny 10:04
Designated beneficiaries that are not an eligible designated beneficiary have 10 years to withdraw the entire account.
Ryan Kilkenny 10:12
Non designated beneficiaries have five years to withdraw the entire account.
Ryan Kilkenny 10:18
For the year of the account owners death, we use the RMD the account owner would have received. For the year following the owner's death, the RMD will be dependent on the identity of the designated beneficiary.
Ryan Kilkenny 10:33
And so what are a few ways that you can lessen the burden or lower RMDs. And so if you're still employed at age 72, you generally do not have to take an RMD on your current employer's retirement plan. The one exception is if you own more than 5% of the company's sponsoring the plan? If so, you will have an RMD.
Ryan Kilkenny 10:56
Next, if you have money in Roth employer accounts, you can simply roll that money into a Roth IRA.
Ryan Kilkenny 11:05
What about moving money from your IRA to an HSA? That's right. You may be able to make a one time distribution of money in your IRA into an HSA, in what is known as a qualified HSA funding distribution. Now, you can only do it once, and you're limited to the annual HSA contribution limit. And you also have to be eligible to contribute to an HSA, meaning you have to be covered by a high deductible health care plan, and you have to maintain that coverage for an entire year after the transfer. But that's another option.
Ryan Kilkenny 11:42
Have you heard about qualifying charitable distributions? If you're over 70 1/2, a qualified charitable distribution, or a QCD, allows you to move up to $100,000 a year from your IRA to charity. QCD's count towards your RMD, and get this, you won't owe any income taxes on the money that you give to charity. So if you donate to charity by writing a check from your bank account, you're doing so with after tax money. That's money that you've already paid taxes on, but donating pre tax money from your IRA means that you can write a larger gift. The key here though, is that the money must go straight from your IRA to the charity. No detours to your personal bank account. Another win is that the charity won't owe any taxes on your donation.
Ryan Kilkenny 12:33
Last but not least, Roth conversions may help lower your RMDs, especially during your retirement gap years, the time between your retirement day and when you turn 72. Yes, you will owe some income tax on retirement money that you convert to a Roth IRA, but it could save you a lot of money in income taxes down the road, and it may also save you a lot in Social Security taxes and Medicare surcharges known as IRMAA.
Ryan Kilkenny 13:01
Alright, there's quite a lot to required minimum distributions, and much more than I can cover in detail in 15 minutes. And as you can see, they can be fairly complicated, easy to mess up, and very expensive.
Ryan Kilkenny 13:15
But that's it for today. If you have any questions, want to learn more, or see if we'd make a good team, you can find me at atomicplanning.com. There's a "Contact Us" button in the upper right hand corner of the website that makes it easy to schedule a Zoom meeting with me.
Ryan Kilkenny 13:30
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Ryan Kilkenny 13:46
This podcast is for informational and educational purposes only, and it is not investment, tax, or legal advice. Clients of Atomic Planning may maintain positions in the securities discussed in this communication. I try my best to bring you valuable information, but I may not know anything about you or your personal situation. So please talk with your fee-only financial planner, tax, and or legal professionals before taking any action or making any decisions about your own financial plan. Atomic Planning is a veteran-owned Kansas state registered investment advisor providing independent tax and retirement planning.