How to Avoid RMD Pitfalls

If you turned 73 this year and own a traditional IRA or 401(k), congratulations on reaching this milestone! However, an important deadline is approaching. You must take your first required minimum distribution (RMD) by April 1 the year after you turn 73. After that, you must take RMDs by December 31 each year.

An RMD is a mandatory withdrawal from retirement accounts such as IRAs, 401(k)s, and 403(b)s. This withdrawal is required by the federal tax code. The SECURE 2.0 Act of 2022 raised the RMD age from 72 to 73 starting in 2023, and it will further increase to 75 in 2033.

While you were working and contributing to a retirement account, your money grows tax-deferred. The IRS doesn’t allow you to defer taxes indefinitely. Eventually, you must start withdrawing from the account and pay taxes on pre-tax contributions and earnings.

What are the Penalties for Not Taking an RMD?

Adhering to the December 31 deadline is crucial. The IRS charges a big fine if you don't take out enough money from your retirement account on time. The penalty is usually 25% of the amount you didn't withdraw. For IRA owners, the penalty can be reduced to 10% if the RMD is corrected within two years.

Do You Take an RMD from Each Account?

For a single IRA, you take your RMD directly from that account. If you have more than one IRA, you must calculate the required minimum distribution (RMD) for each one. Add them together and withdraw the total from any of your IRAs. For instance, you can choose to withdraw the entire RMD from the account with the highest balance.

However, this flexibility does not apply to qualified retirement plans, such as 401(k)s or 403(b)s. For these employer-sponsored plans, you must take a separate RMD from each account. If you have multiple 401(k) accounts, you must withdraw the required amount from each one individually. This means you will receive separate payments from each plan.

Additionally, some 401(k) plan administrators may automatically distribute your RMD each year, while others may not. It’s important to check with your plan sponsor to understand their specific policy regarding RMDs.

How Do You Take the Money Out?

This question often confuses people, but fortunately, you have several options:

Withdraw Cash: Once you know your RMD amount, you can sell shares of stock or funds to generate enough cash for the withdrawal. If your workplace plan only includes mutual funds, your trade will be processed after the market closes. This typically happens by 6 p.m. Eastern Time. This price may differ from the previous day's closing.

In-Kind Transfers: If you don’t need the money immediately, you can transfer shares to a taxable brokerage account in an in-kind transfer. This allows you to move assets without selling them, maintaining your investment while meeting your RMD. However, taxes will be owed on the transfer, including withholding taxes unless you opt out.

Give to Charity: You can donate your RMD to charity as a Qualified Charitable Distribution (QCD), a tax-free transfer that satisfies your RMD requirement (up to $105,000 annually per individual in 2024). The donation must be made by December 31.

While you won’t get a charitable deduction, you avoid taxable income and can still take the standard deduction.

Automatic Withdrawals: You can set up automatic withdrawals for individual and workplace plans. Some services calculate and distribute RMDs according to your instructions.

How Might RMDs Affect Taxes?

RMDs are taxed like regular income and will be added to your total taxable income for the year. This can increase your tax rate and possibly move you into a higher tax bracket. This could also impact taxes on Social Security benefits and Medicare premiums.

Taxes on in-kind transfers are based on the value of the shares at the time of transfer. You will owe taxes on the amount used to prepay some of the tax liability on the transfer. For example, if you originally paid $5,000 for stock now worth $2,500, you’ll pay taxes on the current value. The new value becomes the basis for your shares going forward.

When you take your Required Minimum Distribution (RMD), you can choose to have taxes withheld. The minimum federal withholding rate is 10%, but you can opt for a higher amount if you prefer. Consulting a tax advisor or financial advisor can help you determine the best option for your situation.

Bottom Line

Understanding RMDs empowers you to build a retirement income plan that suits your needs. As the year ends, consider consulting with a tax professional or financial advisor to review your RMD options. This can help you meet your retirement goals and avoid costly tax mistakes.

Sources:
https://www.fidelity.com/learning-center/personal-finance/first-rmd-requirements

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This site may contain links to articles or other information that may be on a third-party website. Advisory Services Network, LLC is not responsible for and does not control, adopt, or endorse any content contained on any third-party website.

This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.

Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.