The ABCs of RMDs

When we were younger many of us tried to sock as much money as we could into 401(k)s and other traditional retirement savings accounts so we’d have a “paycheck” when we quit working. Well for many of us, pay day is here whether we want it or not.

“You cannot keep retirement funds in your accounts indefinitely” the IRS says, which is a polite way of saying Uncle Sam wants its taxes.

Forced withdrawals, known as Required Minimum Distributions (RMDs), begin at age 72 (the age used to be 70 ½). While we can’t change anything about our birthdate, taxpayers do have choices about when in the calendar year to take their withdrawal and how they use the money.

First the Basics about RMDs

The SECURE Act of 2020 changed the age when you need to start RMDs. If you turned 70 ½ in 2020 or later, you should take your first RMD by April 1 of the year after you turn 72. All subsequent ones must be taken by December 31 of each year. (For inherited retirement accounts, RMDs vary depending on the relationship of the beneficiary to the original owner so talk to a financial advisor.)

The exact required withdrawal amount varies each year. To calculate your RMD, divide your year-end account balance from the previous year by the IRS life-expectancy factor based on your birthday in the current year. If you own multiple IRAs, you need to calculate the RMD for each account. However, RMDs do not apply to Roth IRAs because contributions are made with income that has already been taxed. (Remember, RMD is the minimum required, you can withdraw more without penalty.)

Plus if you're married and your spouse is more than 10 years younger than you are — and is named as the sole beneficiary on at least one of your IRAs — the RMD will be less than what this calculator shows. If you are still working, you might be eligible for a work waiver. Consult a financial planner for more details.

Yes, you will pay taxes on the withdrawal and yes there are tax penalties if you ignore the RMD deadline (in most years the deadline is Dec. 31).

Many taxpayers like to schedule an automatic payment for the first of the year, or year end, often to cover just things as holiday gifts and charitable donations (more on this) but there are other options.

According to Kiplinger’s Catherine Siskos:

“Taking the money in installments throughout the year has advantages for retirees who don't need the income. Distributions that are deposited regularly also provide a framework for knowing how much you have to live on so that you don't overspend.”

Others like to watch the market and plan their withdrawals when the account value is high.

Spending your RMDs

Many older adults depend on their RMD to cover living expenses, both routine expenditures and unexpected ones. Others may be in a position to invest the withdrawal, but one caveat - you can’t reinvest the RMD in a tax-advantaged retirement account.

“If your liquid cash cushion is sufficient, consider tax-efficient investing options, such as municipal bonds. Index funds don’t throw off a lot of capital gains and can help keep your future tax bills in check,” writes Kiplinger Retirement Board editors.

Some depend on their RMD to cover the year’s tax bill. (Again, talk to a financial planner or the IRA custodian about setting up such an account.)

And others look to their required withdrawal as a way to support their favorite charities and avoid taxes - people age 70½ and older can transfer up to $100,000 directly to charity in the form of a qualified charitable distribution or QCD each year tax-free. 

Again, from Kiplinger: “The QCD is a particularly smart move for those who take the standard deduction and would miss out on writing off charitable contributions. But even itemizers can benefit from a QCD. Lower adjusted gross income makes it easier to take advantage of certain deductions, such as the write-off for medical expenses that exceed 7.5% of AGI in 2020. Because the QCD’s taxable amount is zero, the move can help any taxpayer mitigate tax on Social Security or surcharges on Medicare premiums.”

In the past, Molly Kavanaugh frequently wrote about Kendal at Oberlin for the Cleveland Plain Dealer, where she was a reporter for 16 years. Now we are happy to have her writing for the Kendal at Oberlin Community.

About Kendal at Oberlin: Kendal is a nonprofit life plan community serving older adults in northeast Ohio. Located about one mile from Oberlin College and Conservatory, and about a 40 minute drive from downtown Cleveland, Kendal offers a vibrant resident-led lifestyle with access to music, art and lifelong learning.