Commonly known as RMDs, required minimum distributions are amounts that the federal government requires you to withdraw annually from traditional individual retirement accounts (IRAs) and work-based retirement plans.
The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. It also helps ensure that people don't just accumulate retirement accounts, defer taxation and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime.
Which retirement savings vehicles are subject to RMD rules?
In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive, but your beneficiary will generally be required to take distributions from it after your death.
Work-based retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans and qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your work-based plan, you should consult your plan administrator or a tax professional.
When must RMDs be taken?
Your first required distribution from an IRA or retirement plan is for the year you reach age 73—or age 75 for those who reach age 73 after December 31, 2032. There is some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 73, or you can delay it until April 1 of the following year.
Since this first distribution generally must be taken no later than April 1 following the year you reach age 73, this April 1 date is known as your required beginning date. Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year—your first year's required distribution and your second year's required distribution.
There is one situation in which your required beginning date can be later than described above. If you continue working past age 73 and are still participating in your employer's retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own 5% or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.
How are RMDs calculated?
RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made.
When calculating the RMD amount for your second distribution year, you base the calculation on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age 73) regardless of whether or not you waited until April 1 of the following year to take your first required distribution.
There is one exception to the procedure described above. If your sole designated beneficiary is your spouse, and they are more than 10 years younger than you, the calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your spouse. These life expectancy factors can be found in IRS Publication 590.
If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. Similar rules apply to Section 403(b) accounts. If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.
Should you delay your first RMD?
You might delay taking your first distribution if you expect to be in a lower income tax bracket in the following year, perhaps because you're no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution must be made on or by December 31 of that same year.
Receiving your first and second RMDs in the same year may not be in your best interest. Since this "double" distribution will increase your taxable income for the year, it will probably cause you to pay more in federal and state income taxes. It could even push you into a higher federal income tax bracket for the year. In addition, the increased income may cause you to lose the benefit of certain tax exemptions and deductions that might otherwise be available to you. The decision of whether to delay your first required distribution should be based on your personal tax situation.
What if you fail to take RMDs as required?
You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 25% excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year.
You report and pay the 25% tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts." The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to "reasonable error" and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return, and attach a letter of explanation. The IRS will review the information you provide and decide whether to grant your request for a waiver.
The SECURE 2.0 Act of 2022 established a two-year period to correct a failure to take a timely RMD, with a resulting reduction in the tax penalty to 10%.
Tax considerations
Income tax
Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal—and possibly state—income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan.
For example, if some of your traditional IRA contributions were not tax deductible, those contribution amounts will be income tax free when you withdraw them from the IRA. This is simply because those dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any after-tax contributions. Special tax rules apply to Roth IRAs and Roth 401(k)/403(b) contributions.
Taxable income from an IRA or retirement plan is taxed at ordinary income tax rates even if the funds represent long-term capital gains or qualifying dividends from stock held within the plan. There are special rules for capital gains treatment in some cases on distributions from retirement plans.
Gift and estate tax
If you do not expect the value of your taxable estate to exceed the applicable exclusion amount, then federal gift and estate tax may not be a concern for you. However, state death—inheritance—tax may be a concern. In some cases, your assets may be subject to more than one type of transfer tax. Consider getting professional advice to establish appropriate strategies to minimize your future gift and estate tax liability.
In addition to federal gift and estate tax, your state may impose its own estate or death tax (or other transfer taxes). Consult an estate planning attorney for details.
Inherited IRAs and retirement plans
Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary will then typically be required to take distributions from the account. A spouse beneficiary may generally roll over an inherited IRA or plan account into an IRA in the spouse's own name, allowing the spouse to delay taking additional required distributions until they turn age 73. Rules for non-spouse beneficiaries depend on whether the beneficiary is an individual (versus a trust or estate), as well as the age and relationship of the individual to the beneficiary. For details, see IRS Publication 590-B.
As with required lifetime distributions, proper planning for required post-death distributions is essential. You should consult an estate planning attorney and/or a tax professional.
As always, the team at Busey Wealth Management is here to help. To learn more about our comprehensive services or find an advisor near you, visit busey.com/wealth-management.
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