What to Know About RMDs Before 73
Turning 73 may not feel like a tax event, but for many retirees, it can be.
Required minimum distributions, usually called RMDs, dictate when you must begin taking money from certain retirement accounts. And because those distributions are generally taxable, they can have a bigger impact on your overall tax picture than you might expect.
The best time to start thinking about RMDs isn't when your first one is due. It's several years before that.
What Is an RMD?
An RMD is the minimum amount the IRS requires you to withdraw each year from certain tax-deferred retirement accounts once you reach the applicable starting age.
Why does the government require you to take money out? Because many retirement accounts allow you to defer taxes while you're saving. Eventually, the IRS wants to collect the tax on that money.
RMD rules generally apply to traditional IRAs and many employer-sponsored retirement accounts, including traditional 401(k) plans. Under current federal law, Roth IRAs do not require RMDs during the original account owner's lifetime.
When Do RMDs Start?
This is where things can get confusing because the starting age has changed in recent years.
Under current law, many people reaching RMD age now begin at 73. The starting age is scheduled to increase to 75 for younger taxpayers in the future. Your exact RMD starting age depends on your birth year, so don't assume that the rule that applied to a parent, spouse, or older friend will automatically apply to you. There are also special timing rules surrounding your first distribution, which can make that first year particularly important from a tax-planning perspective.
If you're approaching retirement or your early 70s, it's worth confirming your individual deadline well before you reach it.
How Much Do You Have to Withdraw?
Your RMD isn't a flat dollar amount or percentage that applies to everyone.
Generally, the calculation uses your retirement account balance from the end of the previous year and an IRS life-expectancy factor. As your account balance changes, so can your required distribution. And remember: an RMD is a minimum. You can generally withdraw more if you need the money, but taking additional taxable distributions can also affect your tax situation.
RMDs Can Change Your Tax Picture
This is the part we really want clients thinking about ahead of time.
Once RMDs begin, you don't get to simply decide you don't need the income this year and leave all of the money in the account. The required amount has to come out. For many people, those distributions are taxable income. That means an RMD could affect more than the balance in your checking account. Depending on your circumstances, additional income can influence your overall tax liability and other income-based calculations.
This is why we don't like looking at retirement accounts in isolation. Your RMDs, Social Security benefits, investment income, charitable giving, and other sources of income all become part of the same financial picture.
What Happens If You Miss an RMD?
Missing an RMD can come with an IRS excise tax on the amount you should have withdrawn. There are provisions that can reduce the tax when a missed distribution is corrected within the applicable timeframe, but that's not something you want to rely on.
Keeping track of the rules and deadlines ahead of time is much easier than fixing a missed distribution afterward.
Why You Should Start Planning Before 73
Before RMDs begin, you may have more options. For example, some retirees have a period after they stop working but before required distributions begin when their taxable income is lower than it was during their working years.
Depending on the situation, that can create an opportunity to consider strategies such as Roth conversions. A Roth conversion moves money from a traditional retirement account into a Roth IRA. You'll generally recognize taxable income on the converted pre-tax amount now, but reducing the balance of a traditional IRA may also reduce future RMDs from that account.
Does that mean everyone should do a Roth conversion before 73? No. It means we have another tool to evaluate while there's still time to plan.
Read our guide to Roth conversions to learn more about when this strategy may make sense.
Give Yourself Time to Plan
RMDs aren't inherently a bad thing. You saved that money for retirement, after all. The important part is understanding how and when those withdrawals will affect the rest of your finances.
If you're getting closer to your RMD starting age, don't wait until the first distribution is due to start asking questions.
We can help you look ahead at your retirement income, taxes, investments, and future distributions so you're not making these decisions one year at a time. Reach out to our team to start planning before your RMDs begin. A little preparation now can give you far more control over how your retirement income and taxes work together later.