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Navigating Retirement: Understanding Required Minimum Distributions

Navigating Retirement: Understanding Required Minimum Distributions

May 31, 2024

Required minimum distributions (RMDs) are the minimum amounts you must withdraw from certain retirement accounts each year. Retirement accounts subject to RMD requirements include Traditional IRA, SIMPLE IRA, SEP IRA and 401(k). Roth IRA doesn’t have an RMD requirement and the Secure Act 2.0 removed such requirements for Roth 401(k).

Time:

Before the SECURE 2.0 Act, the age to take RMD was 72.

The SECURE 2.0 Act raised the age that you must begin taking RMDs to

  • age 73 for those reach age 72 after Dec. 31, 2022
  • age 75 for those reach age 74 after Dec. 31, 2032

After reaching age 73, the deadline for taking an RMD is December 31 each year. However, if this is your first RMD you have the option to delay it until April 1 of the year following the year you reach age 73.

Account owners in a workplace retirement plan (for example, 401(k) or profit-sharing plan) can delay taking their RMDs until the year they retire, unless they're a 5% owner of the business sponsoring the plan.

Calculation:

            The amount of RMD is calculated by dividing the account balance as of December 31 last year by the life expectancy table published by the IRS. An IRA owner must calculate the RMD separately for each IRA they own but can withdraw the total amount from one or more of the IRAs.

For example, John is age 76 and he has two IRA accounts, one with a balance of $80,000 and the other has a balance of $20,000 as of December 31 last year.

RMD amount = 80,000 / 23.7 + $20,000/23.7 = $3375.53 + 843.88 = $4219.41

However, RMDs from Qualified Retirement Plans such as 401(k) must also be calculated separately and can only be taken from their respective accounts.

Penalty:

            Secure Act 2.0 reduced the penalty of failure making timely RMDs from 50% to 25% and the penalty is further reduced to 10% if the taxpayer corrects the failure and files a tax return reflecting paying the penalty within the correction window. The correction window is the earliest of:

  1. The date the IRS issues a notice of deficiency with respect to the excise tax;
  2. The one which the tax is assessed; or
  3. The end of the second taxable year after the shortfall occurred.

One important aspect worth noting is that before Secure Act 2.0, taxpayers who failed to take RMDs can typically correct their error by immediately taking their missed RMD and then filing Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, with their next income tax return requesting a waiver of the penalty. Taxpayers are not required to pay the 50% excise tax when they file their return. Instead, they are only required to pay the tax if the IRS rejects the waiver request.

The new provision under Secure Act 2.0 specifically states that the taxpayer must submit a return during the correction window “reflecting such tax” (the reduced 10% excise tax), which means that taxpayer must pay the tax and request a penalty waiver when filing the tax return and then get a refund if IRS approves the waiver request.

Lastly, consult with your financial advisor to take the RMD properly.