As we amazingly head into late October, it’s time to revisit the topic Required Minimum Distributions, or RMDs.
The government requires certain individuals with a tax deferred retirement plan to take a taxable distribution each year. This distribution is called an RMD.
In 2023, anyone who has attained the age of 73 (yes, this age just changed) is required to distribute from their traditional IRA, employer sponsored 401(k) or 403(b) an amount determined by the individual’s life expectancy. The calculation is based upon a table published by the IRS, and there are a multitude of calculators online that can help. Many IRA and retirement plan custodians have also already sent reminder letters, but some reminder letters are still on the way.
It’s important to note, if you were born in 1951 (the prior age for RMDs) you get to skip a year in 2023 even though you would have been required under last year’s rules. A confusing little rule change.
In addition, those who have an inherited IRA, also called a beneficiary IRA, may also be required to take an RMD. The deciding factor in this decision is whether or not the person the IRA was inherited from was subject to RMD in the year when they passed. If the original IRA owner was taking RMDs, distributions must be continued. If the original owner was not, then the beneficiary has more flexibility in taking distributions but must still have the entire account distributed by the end of the tenth year following the date of death. Those who inherited an IRA before the year 2020 are subject to different rules, but are also required to take annual RMDs.
If this all sounds confusing, it really isn’t, and much of the calculation work and notifications will be provided by the retirement account custodian. Instead of delving to deeply into all the technicalities, I’d rather talk about some planning opportunities associated with RMDs.
As IRA balances grow with the performance of the stock market and now higher interest rates, the RMDs associated with these accounts are also growing, and have the capacity to cause tax and Medicare complications.
Americans have been contributing to the modern version of retirement plans since 1986, and it is now not unusual to see retirees with $2 million to $3 million in IRAs or 401(k)s. According to the IRS, a 73-year-old has a life expectancy of 24.7 years, which equates to someone with a $2.5 million retirement plan being required to distribute a little over $101,000. Add in two inflation adjusted Social Security benefits and maybe a pension, some non-retirement dividends and interest, and before you know it, a couple could be looking at income of close to $200,000, which is an income level subjected to material Federal tax rates as well as potential Medicare premium increases. While this may sound like a good problem to have, the unintended consequences of saving diligently and investing wisely over an entire career are still unintended.
The first step in managing the potential complications definitely begins with awareness. In my experience, people in their late 60s and early 70s have well-established financial habits. For those with larger retirement plans, who aren’t spending material amounts from their retirement plans, the RMD may still be years away, but the writing is on the wall.
For some it can make sense to develop a well-conceived Roth IRA conversion plan, spanning a number of years prior to age 73. Roth IRA do not require RMDs, and while the act of converting a traditional retirement plan to a Roth is taxable, the tax amount may be managed by maximizing tax brackets and being mindful of Medicare income limits. The earlier a conversion plan is started, the more tax years available to spread out the taxes. In addition, current tax rates and standard deductions are very attractive for retirees with income in the $70,000 to $150,000 range. The current tax rules expire in 2025, and so a few years remain to use these rules to their best advantage.
For those concerned about RMDs that may have missed the planning window for Roth conversions, another attractive RMD tax rule is the Charitable RMD or CRMD. A CRMD allows those having attained the age of 70 ½ (yes another age to remember) to give money from their IRA directly to a qualified charity, without the amount distributed contributing to their taxable income. A CRMD has to be handled in a very specific manner, but if done correctly a CRMD effectively passes the income through the tax return without being taxed or added to Medicare income limitations. The CRMD is in my opinion one of the best income planning tools available to retirees.
Once again, the best planning window is the one that opens early. If RMDs now or in the future are causing concern, the time to start planning is now.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
