Required Minimum Distributions – What’s New?
What is a required minimum distribution (RMD)?
A required minimum distribution, often referred to as an RMD, is a specific amount of money the government requires you to take out of your pre-tax retirement accounts (think IRAs, 401(k)s, 403(b)s, etc.) every year starting the April after you turn 72 years old. Starting that December of the same year, every year after that, you are required to take your RMD by December 31st. Pre-tax retirement accounts offer a valuable savings opportunity for many people during their working lives, but are subject to required minimum distribution rules!
As an example, this year Bill makes $60,000 and contributes $6,000 to his IRA. While Bill earned $60,000, only $54,000 of his earned income shows up on his tax return that year because the valuable $6,000 tax deduction. Not only that, the money he invests in his IRA grows tax-free until it is withdrawn! The catch is when Bill is 72 years old, he is required to take a certain amount of money before December 31st of every year for the rest of his life and that yearly amount shows up on his tax return as taxable income.
RMDs are also required to be taken by people who have inherited a pre-tax retirement account from someone. Inherited IRA RMDs are required to be taken by the beneficiary by December 31st of the year following the owner’s death, and then every year after that.
If you fail to take your RMD, you are hit with a 50% penalty of the portion of your RMD you did not take by December 31st in addition to any income taxes due. Yikes!
How are RMDs calculated?
But how much do you have to distribute from your pre-tax retirement account each year? RMDs have to be calculated each year by using the December 31st value of your retirement account from the prior year, divided by your life expectancy factor found on the IRS Uniform Lifetime Table. The age you will be on December 31st is the age you use to determine your life expectancy factor for that year.
Let’s stick with our example of Bill and assume he is now age 74 and loving retirement! His December 31, 2021 IRA account balance was $1,000,000. Using the Uniform Lifetime Table, his life expectancy factor will be 25.5, which means his RMD will be $39,216 for 2022 ($1,000,000/25.5).
For inherited IRA RMDs, it’s important to note there is a different life expectancy table used to calculate RMDs, the Single Life Expectancy Table and the Joint and Last Survivor Life Expectancy Tables (used for a spouse who inherits a pre-tax retirement account who is more than 10 years younger than the original account owner).
What’s new?
The life expectancy tables were recently updated effective January 1, 2022 to reflect our population’s increasing life expectancy. Because we are living longer, the life expectancies used in the tables have been increased, which leads to smaller RMDs.
If this new update had not taken place, Bill’s life expectancy factor at age 74 would be 23.8 causing his IRA RMD to be $42,017 for 2022.
Takeaways
If you are taking RMDs, check to ensure your RMDs for 2022 have been calculated correctly using the updated life expectancy tables.
While RMDs are just that, required – there are many planning opportunities available to you, including charitable giving, withholding for taxes, carefully controlling other sources of income, etc. As financial planners, we assist clients with approaching their RMDs strategically. Depending on client’s specific goals, needs, and financial plan, there can be quite a number of opportunities available to you.