Last Week’s Question of the Week: According to the U.S. Department of Labor, how many Americans over the age of 65 are currently employed? Is it 1 out of 5, or 4 out of 5?
ANSWER: 1 out of 5.
HOST: Today you are discussing RMD’s, what are they, and when do we need to even begin taking them?
KLAAS FINANCIAL: First of all, since there are so many acronyms out there, let’s define RMD. RMD stands for “Required Minimum Distribution.” Your RMD is the minimum amount you must withdraw from your tax-deferred accounts each year beginning after reaching the age of 72.
The majority of us have our retirement investments sitting in tax-deferred accounts such as IRAs, 401ks, 403bs etc. Let’s remember that you received an up-front tax deduction for the amount that you contributed into those accounts and you also continue to receive tax-deferred treatment of any income and gains that the assets in your retirement account generate. That means no tax is due until you start making withdrawals. In other words, without RMDs, you could let your savings sit, untaxed, for your entire life. You could then pass those savings on to your heirs, who could pass it on to their heirs, and so on.
The reason RMD laws were established is that it forces us to take a minimum distribution from these accounts and begin paying taxes on them while we are living. The IRS wants to begin receiving the associated taxes on these accounts! Previously the age established was 70½, but acknowledging that Americans are living and working longer, the Secure Act, which passed in December of 2019, has now increased the RMD age to 72 as of January 1st of this year, applicable to distributions made after Dec. 31, 2019, for individuals who reach 72 from Jan. 1, 2020 or after inheriting any IRA account.
HOST: So, why is this so important? If I miss my RMD, is it a big deal?
KLAAS FINANCIAL: Well, we should note that 2020 is an exceptional year, in case you didn’t already know that! The CARES Act passed in March of this year, which amongst many changes in law, is allowing for the deferral of RMDs that would normally be collected for this year only. All the rules will apply beginning in January of 2021. So, even if you are already collecting RMDs, you can elect to suspend or even roll them back into your accounts. Speak to your tax accountant or financial advisor about this for 2020.
Things to know:
One of the important reasons why you wouldn’t normally want to miss your RMD, is that if you draw less than your RMD, you may owe a 50% penalty tax on the difference…except for this year. Remember that the IRS is not telling you that you have to spend this money, you just have to pay taxes on the money, and many times people just re-invest this in after-tax accounts.
The rules for when IRA beneficiaries must take RMDs depend in part on the account owner’s age on the date of his or her death. If you inherit a Roth IRA and transfer the assets to an Inherited Roth IRA, unlike the original owner, you must take RMDs. As long as the assets have been in the Roth IRA for five or more years, these RMDs can be withdrawn federally tax-free.
HOST: So how much are you allowed to take out for your RMD every year and how is a person’s RMD calculated?
KLAAS FINANCIAL: Remember, your required minimum distribution is the minimum amount you must withdraw from your account each year.
You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts).
How the RMD is calculated: The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.” A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner. Go to investor.gov which is a website hosted by the SEC (Securities & Exchange Commission) and you can calculate what your RMD’s may look like; or go to irs.gov and type in RMD Worksheet and you can do an easy hand calculation.
In 2021 there is likely to be an updated Uniform Lifetime Table. Most notably, this is the first time the tables have been updated since 2002, despite the fact that life expectancy has increased more than 2% (or 1.6 years) for all Americans, and more than 8% for Americans who have reached the age of 65.
Your first RMD must now be taken by April 1st following the year you turned age 72 and subsequent RMDs must be completed by December 31st each year.
Inheriting IRA’s and RMD’s:
- The rules for when IRA beneficiaries must take RMDs depend in part on the account owner’s age on the date of his or her death.
- If you inherit a Roth IRA and transfer the assets to an Inherited Roth IRA, unlike the original owner, you must take RMDs. As long as the assets have been in the Roth IRA for five or more years, these RMDs can be withdrawn federally tax-free.
- With the passing of the Secure Act, non-spouse beneficiaries of IRAs will generally need to withdraw 100% of the investments within a ten-year period which effectively eliminated the former “stretch IRA” provision.
HOST: For those people who are needing to take RMD’s, what can they do with regards to donations to charity?
KLAAS FINANCIAL: This is a great topic to discuss with your financial advisor and your accountant to see if it may make sense in your own situation. Many people are unaware of this opportunity.
Using a QCD is a tax-savvy strategy that allows you to transfer up to $100,000 per year from your IRA directly to a qualified charity. It is only available for IRAs and individuals who have reached RMD age (70½) or older.
What is a QCD? QCD stands for “Qualified Charitable Distribution” rule. Beginning at age 70½, you can have all or part of your distribution made directly from your IRA to a qualified charity (up to $100,000 per taxpayer, per year). Unlike conventional RMDs, QCDs aren’t subject to ordinary federal income taxes. Note that eligible charities include 501(c)(3) organizations and houses of worship, however donor-advised funds and so-called supporting organizations are not permitted to receive QCDs on a tax-advantaged basis. And your children are not a charity.
- Be aware, any amount processed as a QCD counts toward your RMD requirement and reduces the taxable amount of your IRA distribution. This lowers both your adjusted gross income and taxable income, resulting in a lower overall tax liability.
- For a QCD to count toward your current year’s RMD, the funds must come out of your IRA by your RMD deadline, which is generally December 31 each year.
- Funds must be transferred directly from your IRA custodian to the qualified charity.
- Remember, you will not get a charitable deduction, but you will have satisfied your distribution requirement, and you won’t have to pay income taxes on that money.
This Week’s Question of the Week: Beginning in 2020, at what age must you begin taking RMDs…is it age 62 or age 72?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.