One thing that the Internal Revenue Service (IRS) has always made clear to its taxpayers is that “You cannot keep retirement funds in your account indefinitely.” At some point the agency will start demanding that you get money out of tax advantaged accounts and pay taxes on, but when you need to start depends on the type of retirement account you have, and in some cases, if you’ve inherited it.
These mandated withdrawals are called required minimum distributions (RMDs) and come with deadlines, and missing them can lead to penalties. Plus, since these withdrawals are considered taxable income in many cases, they can impact how much you owe the IRS each year, so receiving a penalty on top of having to pay money to the IRS is not advisable.
Why does the IRS insist that taxpayers take RMDs?
As we have stated, retirement accounts are usually tax advantaged, which means that owners of the accounts can put money in pretax to increase their contribution. While this is good to grow the accounts, it also means that the government does not get its dues, and at some point that money has to be taxed. This is why the IRS mandates that these accounts need to be used for their intended purpose when the owner reaches a certain age.
The tax rate depends on where your total income lands within IRS tax brackets. If your RMD pushes you into a higher bracket, you could end up paying more taxes overall, but that also depends on how much money you choose to take out of the account, the IRS might mandate the minimum, but you may want to withdraw more and that needs to be factored in any discussion about taxes.
Before the passing of the SECURE 2.0 Act, those who turned 72 before January 1, 2023, had to start taking their RMDs by April 1 of the following year. Now, if you turn 73 in 2024, you’ll need to take your first RMD by April 1, 2025, but do bear in mind that the second one will be owed by the end of the year, so will have taken out two RMDs in a year which could affect your taxes. These rules apply to various retirement accounts, including:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans
- 403(b) plans
- 457(b) plans
- Profit-sharing plans
- Other defined contribution plans
- Roth IRAs (if inherited) If you are the original owner, this money was not tax exempt and so it can be taken out of the account without extra penalties.
Once you take your first RMD, every following withdrawal must be done by December 31 each year. If you fail to take your withdrawals in a timely fashion, the IRS will issue a penalty and it will still require you to take out the original amount of top of it. The penalty is a hefty 25% excise tax, however, if you correct the mistake within two years, that penalty may drop to 10%.
The IRS provides three different tables to determine your RMD, and the right one for you depends on your situation:
- Joint and Last Survivor Table: Use this if you are married, your spouse is the only beneficiary of your account, and they are more than 10 years younger than you.
- Uniform Lifetime Table: This is for all other original IRA owners who do not meet the criteria above.
- Single Life Expectancy Table: This one applies if you have inherited an IRA.
To calculate your RMD, take your account balance from December 31 of the previous year and divide it by the life expectancy factor from the appropriate IRS table. If that sounds like too much work, there are online RMD calculators that can do the math for you.