Nothing in this life can be certain, except for death and taxes.Benjamin Franklin
Taxes are sure to have a huge part in how you choose to invest your money. No matter which type of traditional IRA or 401(k) you have (except for a Roth IRA), the IRS rules mandate that you make withdrawals when you reach retirement (or near-retirement) age. These are called Required Minimum Distributions (RMDs), and they go into effect when the account holder turns 72 years old. From that point on, your RMD will be taxed as earned income.
But you may not need the money at that moment, so what can you do? Can you reinvest your required minimum distribution? In short, yes, you can turn the RMD requirement into a Roth contribution, with some restrictions. Read on to learn more about our best RMD withdrawal strategies from your Traditional IRA, Inherited IRA, Simple IRA, SEP IRA, and more.
Anyone can open an IRA and begin preparing for their future. Generally, it’s a good idea to open an IRA account early before you’re a retiree. Eventually, you will have to take required minimum distributions (RMDs) from your employer-sponsored savings account. If you don’t, you’ll face a stiff penalty for not taking RMDs.
The RMD rule mandates that income tax-advantaged account holders must begin making withdrawals when they reach 72 years of age. This applies to all tax-advantaged retirement savings accounts, such as IRAs, 401(k)s, and Gold IRAs. Therefore, your RMD requirement will be considered ordinary income, and you will be subject to ordinary income tax based on your tax bracket.
The only exception to this rule is Roth accounts, which do not require RMDs until after the account owner’s death. Roth IRAs are not taxable accounts since Roth contributions are made after the ordinary income tax.
Additionally, some may qualify for an RMD exemption. Typically this applies to individuals over 72 who still work, that do not own more than 5% of the business they work for, or that have a retirement account with their current employer. Individuals who meet the above criteria are not required to take RMDs from their retirement savings account with their current employer until April 1 of the year following their retirement.
All other account holders must begin taking RMDs according to the regular withdrawal schedule.
The regular deadline for taking withdrawals is always December 31 of each year. Missing this deadline will result in 50% of the RMD due in taxes to the IRS. You don’t have to withdraw your RMD all at once; you are allowed to spread the withdrawal over the year, as long as you withdraw the total RMD by December 31.
If you’re wondering, “what month should I take my RMD?” consider your expenses throughout the year so you can plan to keep a steady flow of income. Also, keep in mind that your RMD will be taxed as earned income. There isn’t a one-size-fits-all best time of year to take RMD; it will depend on what you feel most comfortable with. The best way to take RMD is whatever way will ensure you pay the fee by the deadline.
The first withdrawal you make, when you are 72, can be delayed until April 1 of the following year. However, you will then need to take two RMDs in that year.
You are allowed to withdraw more than the minimum amount. RMDs are included in taxable income except for after-tax contributions and withdrawals from inherited Roth accounts.
Your annual RMD is calculated based on your age, the corresponding “life expectancy factor” defined by the IRS, and your retirement account balance.
You must know how to calculate your RMDs since you are responsible for following the IRS’s strict RMD schedule. Underestimating can result in tax penalties during tax season, and overestimating may cause you to take out more money than you need to.
Here’s an example calculation of an RMD: Sally is 76 years old, so her life expectancy factor is 22. If she had $100,000 in her IRA last year, her RMD tax withholding for this year would be $4,545.45.
Note that there are several instances when calculating RMD will differ. For example:
You’ve spent your working years squaring away money for your retirement. Now that you’ve turned 72, it’s time to start putting those savings to good use. But what if you don’t need the money the IRS requires you to withdraw?
Most people open an IRA or 401(k) to save for when they can no longer work. However, many prudent investors find that they have a surplus of money. So, don’t fret if you don’t have an immediate need for your RMDs. There are still plenty of ways to protect your IRA contribution.
Here are just a few ideas for what you can do with your RMDs:
Now, for what you can’t do:
There’s a lot that needs to be considered when planning your retirement savings account, including what will be expected of you when it comes time for federal withholding on required minimum distributions. Before you go investing up to the IRS limit, it’s important to know how you will need to go about getting that money out. The last thing you want is to fall behind on an RMD and pay the 50% tax penalty.
Navigating RMDs is simpler than it seems if you keep the above information in mind and know the specific rules for your IRA account. If you do not want your retirement account to be taxable, you can make a Roth conversion. Unfortunately, there aren’t many ways to avoid taxes on RMD besides the Traditional IRA to Roth IRA conversion method.
If you need additional help figuring out how the RMDs for your retirement savings account will work, it’s always a good idea to consult a financial advisor, tax advisor, or IRA custodian.