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Required Minimum Distribution (RMD)

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By Michael Christodoulou

When you’re working, you may spend decades contributing to retirement accounts such as your 401(k) and IRA. Once you’re retired, though, you’ll likely need to begin withdrawing from these accounts to help pay for your living expenses. In fact, you’ll be required to take money from them at a certain age — but that age requirement is changing, and it could lead to changes in your financial strategy.

Let’s look at some background behind this development. You put in pre-tax dollars to a traditional IRA and 401(k), so your contributions can lower your taxable income and your earnings can grow on a tax-deferred basis. Eventually, though, you must take withdrawals from these accounts or face tax penalties. (A Roth IRA does not have the withdrawal requirement; you can essentially keep the money intact as long as you choose.) 

As part of the SECURE Act 2.0 of 2022, the age at which you must take these withdrawals — technically called required minimum distributions, or RMDs — has increased from 72 to 73. So, if you turn 72 in 2023, you now have another year before you’re required to take RMDs.

The SECURE Act 2.0 also mandates that, in 2033, the RMD age will increase again — to 75 — so, depending on your current age, you may have even more time to plan for the effects of RMDs. Of course, you may need to start taking withdrawals from your retirement accounts before you reach either RMD age — 73 or 75 — so the additional time may not mean much to you. But if you can afford to wait until you must start taking RMDs, what issues should you consider?

Perhaps the most important one is taxes. Your RMDs, which are based on your life expectancy and account balances, are considered taxable income in the year in which you accept the money. If you have sizable amounts in your traditional IRA and 401(k), these RMDs could be large enough to bump you into a higher tax bracket, leading to greater taxation of Social Security benefits and a Medicare surcharge. So, the ability to delay taking RMDs can be beneficial from a tax standpoint, at least for a time. On the other hand, by delaying RMDs, you might eventually have to take bigger taxable withdrawals from your accounts that may have larger balances because they’ve had more time to potentially grow.

You could address the issue of taxable withdrawals by converting your traditional IRA to a Roth IRA before you’re faced with RMDs — and now, you have more time to do so. Roth IRAs have no RMDs, and since a Roth IRA is funded with after-tax dollars, your withdrawals are tax free, provided you don’t begin taking them until you’re at least 59½ and you’ve had your account at least five years. Again, though, taxes are the issue — any pre-tax dollars you convert from a traditional IRA to a Roth IRA will be taxable in the year of the conversion. To reduce this tax hit, you could space out the conversion over several years.

When thinking about delaying RMDs or doing a Roth IRA conversion to avoid RMDs, you’ll need to consult with your tax advisor. But the new RMD age limits do give you more flexibility in these areas, so think carefully about how you might benefit from the added time.

Michael Christodoulou, ChFC®, AAMS®, CRPC®, CRPS® is a Financial Advisor for Edward Jones in Stony Brook. Member SIPC.

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By Nancy Burner, Esq.

Nancy Burner, Esq.

For certain retirement accounts, the IRS requires you to take distributions based upon your life expectancy once you reach the age of 72 ½ (the required age was raised from 70 ½ with the passage of the SECURE Act in December 2019).

As a result of the COVID-19 emergency, the CARES Act suspended the requirement to take these distributions in 2020. There are many who did not yet take a distribution for the year. For them, they can decide if it is a piece of income they need and whether to take it. However, some took their Required Minimum Distribution (RMD) at the beginning of the year and they may now be realizing that they did not need this income and that they do not want to pay the associated income tax on the distribution. Even worse, they may have taken it in January and have found themselves in a position where the time period to return it without taxation has lapsed.  What can they do?

The IRS has issued guidance for individuals who received an RMD for retirement accounts in 2020 prior to the COVID-19 emergency and now wish to return it. Notice 2020-51 provides procedure and rules allowing for a return of these monies in light of the fact that an RMD is not required for this year. In many instances, you may be able to return the distribution, thus eliminating the income tax liability on that amount. Most importantly, this rollback must be done by August 31, 2020.

The ability to return the RMD without tax consequences extends to those who took a lump sum distribution as well as to those who received an amount monthly.  It will also apply to persons of all ages that are the beneficiary of an inherited IRA. Note that while the RMD can be returned, the IRS did not extend these provisions to allow you to “rollback” or give back an amount in excess of your RMD.

In addition to the RMD rollback provisions, the IRS Notice 2020-51 allowed special provisions for Corona-Virus related distributions. If you fall in the broad category of persons impacted by COVID-19, you can receive an early distribution of your retirement account without the 10% additional tax/penalty that would otherwise have been assessed. This is significant if you are under 59 ½ and you need to use funds in your retirement account but wanted to avoid the large penalty. 

If you received some or all of your required minimum distribution from your retirement account in 2020 before the enactment of the CARES Act, you should contact your financial advisor, accountant or attorney to determine whether you qualify for these special rollbacks and if it is in your best interest to take advantage of this provision.  Not all retirement accounts have the same treatment so an individualized look is essential and should be done as soon as possible to comply with the August 31, 2020 deadline.

Nancy Burner, Esq. practices elder law and estate planning from her East Setauket office. Visit www.burnerlaw.com.