Optimize your year end planning: Required minimum distributions (RMD)
Many societal functions were suspended or altered during the COVID-19 pandemic. A few examples include student loan payments, evictions, and the required minimum withdrawals from your retirement plans.
In particular, the IRS opted to delay the age at which you are required to make withdrawals from your retirement plan. If you have an Individual Retirement Account or 401(k) and are nearing retirement age, this is the perfect time to reexamine your financial plan.
What is a required minimum distribution?
A required minimum distribution (RMD) is an amount you legally must withdraw from your retirement account once you reach a certain age.
In other words, you can let your retirement balance grow for as long as you’d like. But, once you reach retirement age, you must start making withdrawals. It generally applies only to tax-advantaged retirement accounts, such as:
- Traditional IRAs
- Simplified Employee Pension (SEP) IRAs
- Savings Incentive Match Plans for Employees (SIMPLE) IRAs
- Other plans: 401(k), Roth 401(k), 403(b), and 457(b) plans
The money grows tax-free, but the government ensures you’ll eventually pay taxes on the funds by putting RMDs into place.
What is the age limit for RMDs?
Usually, you must start making withdrawals when you reach the age of 70 ½. However, the IRS waived RMDs completely in 2020. In 2021, they extended the RMD age limit to 72.
This means that you must take your first RMD by April 1st during the year that you turn 72. After that, you must satisfy your RMDs by December 31st of each year.
Optimizing your tax bill
While making withdrawals, you want to do so in a way that will minimize your tax bill. Reducing your tax burden by just a few percent can easily result in thousands of extra dollars to improve your cash flow in retirement.
And if you don’t take a required withdrawal? The penalty for not taking the required minimum distribution by the deadline is 50% of your required RMD. For most people, 50% of their RMD could be quite a hefty sum that they will miss out on. For this reason, you don’t want to miss making your withdrawal.
You can check out the IRA required minimum distribution worksheet to understand the rules around your withdrawals. To use this worksheet, follow these simple steps:
- Figure out the balance of your retirement account
- Find your age and note the distribution period number
- Divide the balance of your account by the distribution period, and you will get your RMD
Is there a maximum distribution?
There’s one more thing to note when it comes to making withdrawals. While there’s a legal requirement for the minimum you must withdraw, there is no maximum.
Retirees can withdraw more than their required minimum distribution if they choose to. For this reason, we recommend consulting with a financial planner to plan your RMD and optimize your retirement income and tax liability.