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What's Ahead For Your RMDs?

What's Ahead For Your RMDs?

If you've taken a break from the Required Minimum Distributions (RMDs) in 2020 due to the CARES Act, we hope you had a great vacation and are ready to come back and update your retirement strategy.

Next, we recommend looking at your overall financial statement to determine your plan. And you're welcome to the club if you've just turned 72, the age at which the IRS requires you to start cashing out most eligible retirement accounts, such as IRAs and 401 (k) (but not Roth IRA) that you had previously saved pre-tax dollars during your working years.

RMDs should be an integral part of your retirement plan, but it's important to know that they come with strict rules on when and an age-based formula for how much to take. For example, if you are still working after your 72nd birthday, you may not need to earn RMD for some service accounts.

Of course, the rules for retirement can change at any time in the future. For example, in early 2021, a legislative proposal named the Securing a Strong Retirement (SECURE 2.0) passed the House Ways and awaits a Senate decision, the final form of which remains to be determined. The proposal includes Open in a New Window provisions that significantly reduce the penalty for non-payment, increase the starting age to 75 over time, and increase catch-up contributions for those aged 60 and over.

The proposed legislation is bipartisan and would implement a series of major reforms aimed at ensuring a stronger private pension system. However, the timeline and final details continue to change as Congress prioritizes President Biden's main legislative agenda.

No matter what happens, you should consider all of your options right now and make sure you don't miss any important deadlines that could cost you fines.

If you have an asset(s) that are subject to the required minimum distribution, here are two important questions to answer that can help you think about how and when to use an RMD.


How do I calculate and collect my RMD?

A tax advisor or financial professional can help you calculate how much you need to withdraw each year based on your age and your account balance at the end of the previous year.

In any case, after determining the appropriate amount for each year, you can choose to receive RMD distributions yourself. However, some providers allow you to set up automatic withdrawals based on the same age criteria and year-end balances. The appropriate amounts are calculated, then withdrawn, and regularly sent by check or direct deposit.

By automating, you can avoid the potentially costly consequences of forgetting to get your RMD.

Whatever the withdrawal schedule, time matters. The IRS penalty for not receiving RMD or receiving an amount less than the amount requested is high: 50% of the amount is not withdrawn on time. The deadline for making your first RMD is normally April 1 of the following year, at age 72, and December 31 of each year. However, please note that if you decide to wait until April 1 of the year after you turn 72 for your first RMD, it will mean that you will take a second RMD that year, and the additional income may have other tax consequences.


Note: Many people choose to withhold tax from their RMD because it is considered regular income. If you decide not to, put some money aside to pay taxes, and beware, a sometimes insufficient withholding tax can result in a tax penalty.


What should I do with my RMD?

You have many options for how to use your withdrawals. 

Living Expenses

If you plan to use RMD to pay for living expenses, it's usually a good idea to budget for your retirement. Defining and having a budgeting process can help you estimate your living expenses, manage your cash flow, and determine if you should use your RMD to fund your retirement lifestyle.

New Investments

Other income and Social Security benefits may cover initial expenses for some retirees. Keep in mind that even if you don't need RMD money to fund your retirement expenses, you will still need to withdraw them from the appropriate retirement accounts. Although your RMD cannot be transferred to an IRA, you can deposit money into taxable brokerage accounts and then transfer the income from the RMD according to a strategy that suits your needs.


Transferring the assets to a loved one

There are lots of smart ways to transfer money to your loved ones. If you want to help someone advance with their education, consider using the money you receive for RMD to fund a 529 college savings account. Another option to consider is to convert some of your traditional IRA assets into a Roth IRA, which will help with the inheritance without any tax consequences. With this "Roth conversion" strategy, you will pay income tax on the converted amount, but you no longer have to worry about the RMD of this amount, as RMD is not required during the lifetime of the real account owner in a Roth IRA. 

Remember, if you are over 72, you will need to get an RMD for the current fiscal year before you can convert it to a Roth IRA; in other words, Roth conversions do not meet the RMD requirement, although all or part of the RMD can be used to pay the conversion fee. On the other hand, if you expect your heirs to be in a much lower tax bracket than yours, or if you plan to leave the IRA assets to charities, the conversion may not make sense. Also, have it in mind that the Roth conversion rules may change in the future, so we recommend that you stay up to date with the latest tax reform legislation.

Although Roth IRA distributions are generally not subject to federal or state income tax for the original owner's life, the balances are still subject to property tax, so it is important to plan accordingly. Since there are several ways to transfer money to heirs, such as trust funds and gifts, consult a wealth planning consultant before deciding.


Charitable Donations

If you have to satisfy a required minimum distribution (RMD) and want to donate to a charity, consider a Qualified Charitable Distribution (QCD).

A QCD directly transfers funds from your IRA custodian, payable to a qualified charity. When you turn 72, the QCD amount will be considered for RMD for the year, up to an annual maximum of $100,000. It is not included in the gross income and is not taken into account when deducting charitable contributions. These can be significant benefits for some high-income earners.

Thanks to changes to the Tax Cut and Jobs Act (TCJA), many retirees can now choose to take advantage of the standard tax deduction ($12,550 for an individual; and $25,100 for couples in 2021) instead of itemizing. Qualified charitable distribution can be a useful alternative for these people as they are not reliant on itemization, just like other important charitable contributions.


The most important thing is to plan.

Whichever scenario works for you, RMDs could play an important role in your retirement finances. Developing a well-thought-out retirement plan can help you use your RMD more effectively and achieve your important financial goals. At the very least, it's important to take the time to understand your RMDs and options with a finance and tax professional, make sure you meet IRS requirements, and avoid a costly tax mistake.


Summary

  • Congress has allowed people to suspend the minimum distributions needed for 2020 as part of COVID-19 relief, but RMDs are back for 2021 and beyond.

  • Each person's RMD status will be different, but you must take the full amount needed. Otherwise, you risk penalties from the IRS.

  • Keep an eye on Congress for news of possible changes to the RMD rules that may arise under the proposed legislation. As usual, we will always bring you updates on any tax-related matter.

  • Planning what to do with the money can help reduce taxes and increase reinvestment options.


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