Last Week’s Question of the Week: In the United States, an average retirement spans how many years? Is it 23 years or 18 years?
ANSWER: The average retirement lasts about 18 years.
HOST: I know we throw a lot of acronyms around on this show, but today we are keeping it down to just one important one that people in retirement need to understand; RMD’s.
KLAAS FINANCIAL: Yes, it really is an important term that people need to become familiar with as they take income in retirement. RMD stands for Required Minimum Distribution.
Bottom Line: You have been putting away retirement funds into your retirement plans for probably three decades or more, and your accounts have been growing tax deferred which is a really good thing for your portfolio. Unfortunately, you cannot keep retirement funds in your account indefinitely. The IRS does want to start collecting their tax monies at some point. Therefore, 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 (RMD’s) from your retirement accounts 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).
Therefore, the question is when must you begin taking these distributions out, from where must you take them, and how much must you take out? This is where things changed beginning in 2020 and will continue to evolve.
When: Previously, we discussed that the RMD age was at 70½ but with the passing of the Setting Every Community Up for Retirement Enhancement Act (SECURE) signed into law in December of 2019, you generally have to start taking withdrawals from your IRA, SIMPLE IRA, SEP IRA, or retirement plan account, by the age of 72. Said another way, if your 70th birthday is July 1, 2019 or later, you do not have to take withdrawals until you reach age 72.
- IRAs (including SEPs and SIMPLE IRAs): April 1 of the year following the calendar year in which you reach age 70½, if you were born before July 1, 1949. April 1 of the year following the calendar year in which you reach age 72, if you were born after Jun 30, 1949.
- 401(k), profit-sharing, 403(b), or other defined contribution plan : Generally, April 1 following the later of the calendar year in which you: reach age 72 (age 70½ if born before July 1, 1949), or retire (if your plan allows this).
From Where? The minimum distribution rules discussed below apply to:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans from prior employers
- 403(b) plans from prior employers
- 457(b) plans from prior employers
- Profit sharing plans from prior employers
- Other defined contribution plans
- ROTH Accounts: However, ROTH IRAs do not require withdrawals until after the death of the owner. ROTH 401ks do have RMDs, so you will want to roll those over to a ROTH IRA in order to not have to make a distribution.
HOST: So how is the amount for the Required Minimum Distribution calculated every year? I think it changes every year for most people doesn’t it?
KLAAS FINANCIAL: Yes, so there are two changing parts of the equation every year. First, your age changes, and your account balances on your retirement accounts change as well.
It’s worthy to note that 2020 was unique due to the fact that the CARES ACT which passed in March, allowed for people to skip their RMD’s for the calendar year 2020. This is something that has never occurred before. But, moving in 2021 RMDs will be coming out as scheduled, unless something changes.
The equation: You take your December 31st prior year retirement balances and divide this number by a life expectancy factor determined by using the Uniform Lifetime Table. This table outlines the percentage for calculating RMDs during an account owner’s lifetime and can be found on the irs.gov website. Or you can go to investor.gov and find an automatic RMD calculator.
An example: The current table for 2021 shows that if you are turning 72 in 2021, you take your account balances of your pre-tax accounts on December 31st of this year, and either divide by your life expectancy, which is 25.6%; or multiply your account balance by 3.91%. So, if your account balance was $100,000, then you would have to take out or $3900 in 2021 and pay taxes on that amount.
Other things to note:
- Younger Spouse: If the sole beneficiary of your IRA for the entire year is your spouse who is more than ten years younger than you, the Joint Life Expectancy Table can be used. There are also special rules that apply for death and divorce.
- New Tables: After reviewing improvements in mortality since RMD life expectancy tables were last updated in 2002, the IRS has provided for an overall moderate reduction of RMDs utilizing newly updated tables and will go into effect in calendar year 2022.
- RMDS are calculated separately for each IRA but then may be aggregated and the total amount taken from one IRA.
HOST: What if you forget or neglect to take your RMD out for the year?
KLAAS FINANCIAL: If you fail to take your RMD by the deadline there is 50% penalty on the amount of the shortfall. If you miss your RMD for the year, you should take it as soon as possible. You should consult with your tax advisor about filing Form 5329 and asking for a waiver of the penalty. The IRS will waive the penalty for good cause.
Also, we get questions about RMD’s for people who have inherited IRA’s. Inherited IRAs are also normally subject to RMDs. How much must you take every year? This changed in 2020, whereas previously you had to begin them for your specific age and then take out the RMD over your life span. If you inherited the account prior to 2020, you’re required to take distributions based on your own life expectancy. Beneficiaries who inherit this year and later are required to draw down the inherited account in 10 years, due to the SECURE Act.
This Week’s Question of the Week: At what age must you begin to take Required Minimum Distributions from your retirement accounts if you were born after June 30, 1949? Is it 55, 69, or 72?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.