Travel To Wealth: RMDs Explained: Demystifying the Rules and Calculating Your Withdrawals

Sunday, February 25, 2024

RMDs Explained: Demystifying the Rules and Calculating Your Withdrawals

Key points:

You can withdraw more than the RMD amount.
RMD withdrawals are taxed as income.
Qualified Roth IRA distributions are not counted as Required Minimum Distributions (RMDs).
Roth conversions don't fulfill the RMD requirement .^[4] You must take your RMD for the year before converting to a Roth IRA. The RMD amount is considered a taxable distribution and is not eligible for conversion.
Failing to take RMDs results in a 50% penalty ( reduced to 25% by SECURE 2.0 , potentially 10% if corrected within two years).
Roth IRAs do not require RMDs while the owner is alive.
A 76-year-old with a $100,000 IRA balance would have an RMD of approximately $4,219.41 in 2024, which is about 4.22% of their account balance.
Different rules apply to beneficiaries inheriting retirement accounts.

What are RMDs?

Required Minimum Distributions (RMDs) are the minimum amounts you must withdraw from certain retirement accounts each year, starting at age 72 or 73 (see next section). This applies to traditional IRAs, SEP IRAs, SIMPLE IRAs , and most employer-sponsored retirement plans.

Starting Age for RMDs Increased to 73 under SECURE 2.0 Act

Here's a breakdown:

Previously: Individuals were required to begin taking RMDs from their retirement accounts by April 1 of the year following the year they turned 72.
Current: Due to the SECURE 2.0 Act , the starting age for RMDs has been increased to 73 for individuals born after December 31, 1949. This means they can delay their first RMD until April 1 of the year following their 73rd birthday.

It's important to note that this change only applies to individuals born after 1949 . Those born in 1949 or earlier are still subject to the old rule of starting RMDs at age 72.

Protect Your Retirement: Consider a Roth IRA Conversion Before Tax Rates Rise

Consider this scenario:

You have a $1 million traditional IRA.
After 2025 , tax rates in the US might increase significantly .^[3]

Currently, with a 4.22% RMD (required minimum distribution), your taxable income would increase by roughly:

$42,200 (based on a $1 million balance)

This increase could push you into a higher tax bracket in the future.

Converting some or all of your IRA to a Roth IRA before 2026 might help you:

Pay taxes on a potentially lower income now .
Avoid potentially higher taxes in the future .

Remember, this is a simplified example. Consulting a tax advisor is recommended for personalized advice .

Executive Summary of RMD Information:

Who is affected?

Owners of traditional IRAs, SEP IRAs, and SIMPLE IRAs.
Most participants in employer-sponsored retirement plans (exceptions may apply).

When do RMDs start?

The first RMD is due by April 1 of the year following the year you reach age 72 (73 if born after 1949).
If you reach 72 in 2022, you have two RMDs in 2023: one by April 1 and another by December 31.

How are RMDs calculated?

Divide your tax-deferred accounts' balance at the end of the previous year by a life expectancy factor provided by the IRS.

Note: This summary provides a general overview and is not a substitute for professional tax or financial advice. Consult with a qualified professional for specific guidance.

Understanding RMDs: How to Calculate Your Minimum Withdrawal Amount

Here's a more detailed explanation of how RMDs are calculated:

1. Gather Information:

Account Balance: You'll need the fair market value of all your retirement tax-deferred accounts as of December 31st of the previous year. This information can be obtained from your financial institution or custodian.

Life Expectancy Factor: The IRS publishes life expectancy tables in Publication 590-B : Distributions from Individual Retirement Arrangements (IRAs) . You'll need to choose the appropriate table based on your situation:
- Single Life Expectancy Table: This is used if you are inheriting an IRA (beneficiary).
- Uniform Lifetime Table: This is the most common table used by individuals with no spouse younger than them by more than 10 years.
- Joint and Last Survivor Table: This is used if you have a spouse younger than you by more than 10 years who is the sole beneficiary of your account.

2. Perform the Calculation:

Once you have the necessary information, use the following formula:

RMD = Account Balance / Life Expectancy Factor

Example:

Scenario: Let's say your traditional IRA balance on December 31st, 2023, is $100, 000, and you are 76 years old (using the Uniform Lifetime Table).

Calculation: According to the IRS tables, the life expectancy factor for a 76-year-old using the Uniform Lifetime Table is 23. 7. Therefore, your RMD for 2024 would be:
- RMD = $100, 000 / 23. 7 = $4, 219. 41

Important Points:

The RMD calculation is done annually , and the life expectancy factor changes as you age, resulting in a potentially lower RMD each year.

You can find the life expectancy tables and additional information on calculating RMDs on the IRS website .

This is a simplified explanation, and there might be additional factors or exceptions depending on your specific situation. It's always recommended to consult with a qualified financial advisor or tax professional for personalized guidance on calculating and managing your RMDs.

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