Focus on Finance: Required Minimum Distributions

August 9, 2023

Required Minimum Distributions, or RMDs, are one of life’s realities that may make you want to cover your ears or put your head in the sand. What does this mean? Why do you need to know about it? Can someone just do it for you? All questions that many retirees and soon-to-be retirees may be asking when presented with this fact of life for so many investors. 

Whether you’re preparing for retirement or already enjoying it, one thing remains true: You want to make the most of your income and protect it from unnecessary penalties. Easier said than done, especially when RMD rules change from time to time, and both RMDs and withdrawal strategies have tax consequences. 

Let’s take it from the top! RMDs are required minimum distributions investors must take every year from their retirement savings accounts, including traditional IRAs and employer-sponsored plans such as 401(k)s and Roth 401(k)s, when you reach RMD age (generally 73). 

A recently signed law, dubbed Secure 2.0, is changing the rules governing how and when certain retirement savers can withdraw money from their accounts. If you’re turning 73 this year and taking your first RMD, you have until April 1, 2024, to do so. For each subsequent year, you must take your RMD by Dec. 31. Keep in mind, if you delay your initial RMD until April 1, you will be responsible for two withdrawals that year (one by April 1 and one by Dec. 31), which could result in a larger tax liability. If you’re older than 73 (as of today), you must take your RMD by Dec. 31 each year. 

Also starting in 2024, investors in employer retirement plans like Roth 401(k) accounts will no longer have to take RMDs. This change aligns Roth 401(k) with Roth IRAs, which don’t require distribution during one’s lifetime. That discrepancy was a big reason for Roth 401(k) owners to roll money out of their workplace retirement plan to Roth IRA—thereby avoiding RMDs and allowing retirement funds to continue growing tax-free. 

Here is a list of retirement accounts requiring RMDs 

  • Traditional IRAs 
  • Simplified Employee Pension (SEP) IRAs 
  • Savings Incentive Match Plan for Employees (SIMPLE) IRAs 
  • 401(k)s 
  • Nonprofit 403(b) plans 
  • Government 457 plans 
  • Profit-sharing plans 
  • Other defined contribution plans 

A frequent question regarding RMDs is what I should do with the money I’m required to withdraw and how is the amount calculated.  Here are just a few options: 

Living Expenses: If you plan to use RMDs to pay for current living expenses, it makes sense to have a budget in retirement. Going through the budgeting process can help you estimate living expenses, manage cash flow, and determine if you’ll need RMDs to fund your retirement lifestyle. 

New Investments: For some retirees, Social Security benefits and other income may cover your expected expenses. If you calculate that you won’t need your RMDs to fund your retirement expenses, you could put them into taxable brokerage accounts, and then invest your RMD proceeds according to a strategy that fits your need. 

Wealth Transfer to a Loved One: There are several tax-smart ways to pass money to your loved ones. If you’d like to contribute to a grandchild’s education (or anyone’s), you can use the RMD money to fund a 529 college savings account. Another option is to convert some of your traditional IRA assets to a Roth IRA, which can be inherited without as many tax implications. With a “Roth conversion” strategy, you’ll pay income tax on the amount you convert, but you’ll no longer have to worry about RMDs on that amount because RMDs are not required during the lifetime of the original account owner in a Roth IRA. 

Charitable Donations: If you have to satisfy an RMD and you would like to make a gift to charity, then consider a qualified charitable distribution or QCD

Calculating RMD amounts can get tricky and it’s probably best to consult a financial planning professional. In general, the formula looks at the following factors: 

  • Your age as of Dec. 31 of the current year and your corresponding life expectancy factor according to the IRS table
  • You’ll also need to know your retirement account balance as of Dec. 31 of the previous year, adjusted to include any outstanding rollovers or asset transfers that weren’t in the account at year-end. 

Whichever road you take in retirement, RMDs are likely to play an important role in your future. Building a thoughtful retirement income plan can help you use your RMDs in the most effective way and help you reach your important financial goals.