What a Required Minimum Distribution (RMD)?
One of the most popular questions I'm asked is what is a Required Minimum Distribution or RMD, and how do they work? It got repetitive enough that I decided to make a video about it. After I made the video I decided that I would do one better, and write a blog post for those who are "readers" and not "watchers" so here we go. Below you will find everything you ever cared to know about RMD's and maybe even a little more!
First off, what is it?
A required minimum distribution is a government mandated distribution. You read that right, the government makes you take distributions from your qualified retirement accounts once you hit a certain age. The reason is simple, for many years through the tax code they let you catch a tax break by contributing to a retirement account. Then they let that money grow tax deferred. Now it's time to pay the tax man! RMD's exist so that the government can begin taxing those deferred retirement assets that you have accumulated over the years. For a long time RMD's began at age 70 1/2, with the passage of the SECURE Act at the end of 2019 that date was moved back to age 72 for those who had not yet started their RMD's. There has been some additional talk of pushing that date back even more, but as of this writing (typing?) the current RMD starting point is the year you turn 72.
How much is an RMD?
The quickest answer is: It Depends. The longer, but more informative answer is - the amount of your annual RMD is calculated by using a factor from something called the Uniform Life Table. You can find it on the IRS website. What it does is essentially gives you a factor by which you divide your retirement account balance to come up with your RMD. As an example - the current factor at age 72 is 25.6. To calculate your RMD you would take your account balance as of 12/31 of the prior year divided by this number. For example if you had $200,000 in retirement assets subject to RMD's, your RMD would be $7,812.50 ($200,000/25.6). That represents a percentage of almost 4% (3.906% for the math nerds). The factor gets smaller each year, which essentially means that the distribution percentage will get larger. Going back to the chart we can see that at age 80 the factor is 18.7. If you had the same $200,000 in retirement assets your RMD for that year is $10,695, which is around a 5.3% distribution rate. That process continues as time goes on, each year the percentage of your accounts you are required to distribute will get larger.
How can I avoid my RMD's?
This is a question that comes up often when reviewing RMD's with people. The short answer is you cannot. You aren't going to get around meeting your RMD. It's part of the rules of qualified retirement accounts, and unless you want to run afoul of the tax man (you do not!) you're going to have to plan for and take these distributions. Now there are a few ways to limit your tax liability. A popular one is a charitable gift. For those who are RMD age - you are allowed to give your RMD to a charity and as a result you won't pay taxes on that money. It's what's called a Qualified Charitable Distribution or QCD. This used to be something congress decided on each year, but in 2015 they made it part of the permanent tax code. Essentially with a QCD you can distribute your RMD to a charity and it will meet your RMD without the distribution being subjected to income tax. If you are charitably minded it can be a great way to meet those goals without adding to your tax bill. The second way to limit an RMD is through something called a QLAC or Qualified Longevity Annuity Contract. It's a rather involved bit of planning, but the short version is that it allows you to take some funds from your IRA, move them into the QLAC to be distributed later, and for those funds to not be subject to the RMD now. It's more complex than that, and really what it has done has kicked the can down the road, not eliminated the RMD, but it can be a solid tool for the right person.
Another potential option is a Roth conversion. This is where you pay tax on a portion of your retirement money to move it into a Roth IRA which is not subject to future tax. Now let's be clear, you are paying taxes here to get the money from the Traditional IRA into the Roth, you are simply protecting that money from future taxation by getting it to the Roth. I've got lots of videos and blog posts about this, if you're curious feel free to poke around. There's lot of stuff here for you on Roth conversions.
What if I don't take my RMD's?
The natural inclination of some folks is to make like an ostrich. When something challenging comes up, they put their proverbial head in the sand and ignore the problem. DO NOT DO THAT with your RMD's! It's just going to create bigger problems for you down the road. The IRS penalty for not taking an RMD is 50%! That's a penalty of 50% of the RMD amount, PLUS you still have to take the RMD and pay taxes on it. Don't be an ostrich! Meet your Required Minimum Distribution!
So what do I do?
There is a lot of planning that goes into your own personal RMD strategy. It's different for every family depending on a variety of factors. While we've talked some of the basics today, and I hope you learned something, there is no substitute for personal planning. Ask your financial advisor for help in planning for your RMD's. If you don't have an advisor, feel free to reach out - I'm happy to help you navigate all the specifics of your own RMD options.