Little-Known Facts That Can Make a Difference
If you’re nearing or living in retirement, it’s likely you’re at least somewhat familiar with the rules surrounding required minimum distributions (RMDs). As a refresher, by April 1 following the year you reach age 73, you must start taking distributions from your tax-deferred retirement accounts, per IRS rules. Each year after that, you must continue taking RMDs or face severe penalties from the IRS.
Even if you’re already taking RMDs, you may not be familiar with all the rules surrounding them. Here, we highlight five lesser-known facts about RMDs.
RMD rules can differ for inherited IRAs.
If you inherit an IRA or another tax-deferred account from someone other than your spouse, you may be required to withdraw the full balance of the account within 10 years. This is a recent change from previous rules that allowed payments to be stretched out of the course of a beneficiary’s lifetime.
IRA RMDs can be aggregated.
If you own multiple traditional IRAs, you have the option to aggregate the RMD amount and take the total distribution from one or more accounts of your choice. This flexibility allows you to strategically plan your withdrawal strategy in order to optimize your tax situation.
401ks and IRAs have slightly different RMD rules.
Unlike IRAs, the IRS doesn’t permit the aggregation of employer-sponsored plan RMDs. That means if you have multiple employer-sponsored retirement plans, such as 401ks and 403bs, you must take an RMD from each account based on the same life expectancy factor that applies to IRA distributions.
Another important difference between IRAs and 401ks is that if you’re still working at age 73 (and don’t own more than 5% of the company), you can choose to delay taking your first 401k RMD until the year in which you stop working. However, you must begin taking IRA distributions at age 73 whether or not you’re still working.
The tax withholding on RMDs is optional.
IRA providers typically withhold 10% of RMD distributions as a payment to the IRS. However, this payment is completely optional. If you prefer to have less or more than 10% withheld, simply notify your IRA provider. Your wealth manager may recommend modifying your withholding amount if it makes sense to do so based on your personal financial situation.
Regardless of the amount withheld at the time of your RMD, you’ll still be responsible for paying taxes on your distribution at your ordinary income tax rate.
The penalty for missing an RMD can be waived.
Most people know that if you fail to withdraw the required RMD amount, you’ll be assessed a 25% penalty on any amount you didn’t withdraw. However, did you know that penalty can be lowered or waived in certain situations?
If you take the necessary RMD by the end of the year following the year in which it was due, the penalty drops to 10%. The penalty may be waived completely if you’re able to establish that the missed distribution was due to reasonable error and that you’re taking steps to remedy the shortfall. In order to qualify for a waiver, you must file IRS Form 5329 and attach a letter of explanation.
Feeling overwhelmed by RMD provisions? Don’t be. Creative Planning is here to help you navigate a wide range of financial and tax challenges, including RMDs and other retirement account distributions. For more information, schedule a call with a member of our team.