What are RMDs and how do they affect you?

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What are Required Minimum Distribution (RMDs,) and how do they affect you?

Jan 1, 2024, 6:01:18 PM | Reading Time: 4 minutes

Throughout your working years, you will likely contribute to your retirement accounts to accumulate funds for the future. Once you reach a certain age, IRS rules require you to draw down your savings from certain accounts and pay income taxes. These withdrawals are required minimum distributions (RMDs) and generally must be taken each year by December 31 once you reach a certain age. Let’s explore RMD rules and which options you have to make the most of your retirement savings and avoid unnecessary penalties.

Understanding RMD rules

RMDs apply to qualified retirement savings accounts, which are funded with pre-tax earnings and have an account value that can grow on a tax-deferred basis. Accounts that require RMDs include:

Employer-based retirement plans like a pension (defined benefit, 401(k), or 403(b)
Profit-sharing plans
Employee stock ownership plans (ESOPs)
Traditional individual retirement accounts (IRAs)
SEP IRA
SIMPLE IRA
457(b) plans if money is deferred on a pre-tax basis

In general, you must begin taking withdrawals from your retirement plan account at age 72 (age 73 if you turn 72 after December 31, 2022.1)

"You can withdraw more than the minimum amount if you so choose," share Tyler De Haan, Certified Financial Professional and Director of Advanced Sales at Sammons Financial Group. “Just remember that your withdrawals are commonly included in your taxable income."

Calculating RMDs

Regarding RMDs, each person’s annual payment will be calculated based on age, account balance, and a life expectancy factor published by the IRS. When you reach the specified age, you will be required to take a minimum withdrawal from each account with a balance.

It’s important you do not miss taking RMDs, since you could be subject to a 25% tax penalty if you fail to pay the minimum amount on time. If you pay as soon as possible, this tax penalty may be reduced to 10%.“Though there may be benefits to delaying RMDs to age 73 and 75 after Secure 2.0’s passage. It may make distributions larger and increase the amount of taxable income in later years of retirement,” adds De Haan. “This is one of the reasons why it is important to evaluate your financial plan to help minimize taxation throughout your entire retirement to make sure there are no unintended consequences.”

Like many tax-related issues, RMDs can be complicated, so talk to your tax advisor or financial professional before making any decisions. They can help you calculate your minimum distributions and discuss ways to minimize the impact of your RMDs.

Annuities and RMDs

If you have an annuity housed within a retirement account, like a 401(k) or IRA, you will be required to follow RMD rules. However, if your annuity is held in a Roth IRA, which is not subject to RMDs, you will not be required to withdraw annually.

Ideas for RMD money

Required minimum distribution rules require you to start drawing income from qualified retirement savings accounts by April of the year after you turn the specified age, whether you need this income or not. While you must take these annual withdrawals, you can choose how to utilize this money. Here are some ways you may put that money to use:

Reinvest your distributions

If you do not need the money from your retirement accounts, you could consider reinvesting your withdrawals in a taxable investment account to potentially grow your savings down the road.

Treat yourself

You may not need your withdrawals to cover daily expenses. If this is the case, you could use this money to go on a dream vacation, tackle a home renovation or purchase a new car.

Create an emergency fund

If you haven’t established an emergency fund or have depleted some of your reserves, now could be a great time to build that amount for the future.

Pay for tuition

You can use the money from RMDs to help pay for your grandchildren’s college education. Paying tuition directly to the school could avoid the gift tax concern, or you could consider contributing to a 529 college savings plan.

Share with family

Giving money to your loved ones may be a good option, but gift tax limits may apply. Consult with your tax adviser to understand the best way to gift your family money.

Give to charity

If you have a charity or cause that you’re passionate about, donating your RMD can be a great option. Donating your RMD is considered a qualified charitable distribution (QDC) and will not be taxed up to $100,000. Talk to your tax adviser to learn more about RMDs and charitable giving. De Haan emphasizes, “the QCD must be sent directly to a 501(c) charity and you cannot take receipt of the funds.” Understanding RMDs, calculating them, and following rules are important to avoiding penalties and making the most of your hard-earned savings. As you plan for retirement and think about your future, consider meeting with your tax advisor and financial professional to find ways to minimize taxes in retirement and gain the knowledge you need to feel more financially empowered when the next chapter begins.

¹ IRS, Retirement Plan and IRA Required Minimum Distribution FAQs, irs.gov

Neither Midland National nor any financial professionals acting on its behalf should be viewed as providing legal, tax, or investment advice. Please rely on your qualified tax professional.

The term financial professional is not intended to imply engagement in an advisory business in which compensation is not related to sales. Financial professionals are independently contracted with(Midland National and are insurance licensed that will be paid a commission on the sale of an insurance product.

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