Avoiding Common RMD Pitfalls for Lower Retirement Taxes: A Guide to Seven Frequent Mistakes
Retirement savings can be a complex matter, especially when it comes to Required Minimum Distributions (RMDs). The SECURE 2.0 Act has introduced several changes to RMD rules, which can cause confusion for retirees. Here's a breakdown of some common RMD mistakes and their associated tax consequences.
Missing the RMD Deadline
Individuals must take their RMD by December 31 each year (or April 1 for the first RMD). Failure to do so results in a penalty of 25% of the amount not withdrawn, though SECURE 2.0 has reduced this compared to a prior 50% penalty. If corrected within two years, the penalty may drop to 10%.
Ignoring Inherited IRA RMD Rules
Beneficiaries of inherited IRAs from post-December 31, 2019 deaths must begin RMDs starting in 2025. Failure to take these RMDs results in the same 25% penalty. Many beneficiaries are unaware due to complex new rules.
Assuming RMDs can be Delayed Indefinitely while Working
The exception delaying RMDs while still employed only applies to the current employer's plan, not IRAs or other plans. Incorrect assumptions lead to missed RMDs and penalties.
Failing to Satisfy RMDs before Roth Conversions
Under SECURE 2.0, you must take the total aggregated RMD from all IRAs before converting any amounts to a Roth IRA. Failure results in the conversion being considered invalid for tax purposes, potentially increasing tax liabilities.
Misunderstanding the New Starting Age for RMDs
The SECURE 2.0 Act raised the RMD age to 73 for those born 1951-1959 and 75 for those born in 1960 or later. Taking RMDs too early or late can cause tax inefficiency or penalties.
General Failure to Take RMDs from Retirement Accounts
Aside from deadlines, not taking the required minimum amount triggers penalties, previously 50%, but lowered under SECURE 2.0.
These mistakes mainly cause penalties ranging from 10% to 25% on the missed RMD amount, along with owing regular income taxes on the undeclared distributions. Correcting mistakes promptly is key to reducing penalties.
Other Considerations
- High taxable income in retirement can impact taxes on Social Security benefits and push retirees into higher tax brackets. Missing opportunities such as Qualified Charitable Distributions (QCDs), if eligible, could result in higher taxable income than necessary.
- Not accounting for significant changes in a portfolio's value in volatile markets could lead to RMD miscalculations. Market downturns might impact your RMD, and not adjusting for upswings could lead to insufficient withdrawals and associated penalties.
- To calculate the RMD, you need to find your account balance as of December 31 of the previous year, look up your life expectancy factor from the IRS table based on your age when you take the RMD, and use the formula: RMD equals Account Balance divided by Life Expectancy Factor.
- Your modified adjusted gross income (MAGI) in retirement can increase Medicare premiums and limit eligibility for certain deductions and credits. High taxable income in retirement due to RMD mismanagement can have a cascading effect on various aspects of a retiree's financial situation.
- Retirees can fulfill their RMD by making a Qualified Charitable Distribution (QCD) directly from their IRAs to a qualified charity, allowing them to donate up to $105,000 annually without being counted as taxable income. By using QCDs to satisfy RMD requirements, retirees can support charitable causes while minimizing the impact on their taxable income.
- Most beneficiaries must withdraw these amounts within 10 years following the account holder's death (the 10-year rule), with specific rules depending on the beneficiary's relationship to the deceased.
In light of these complexities, it's essential for retirees to consult a financial adviser or tax professional if they're uncertain about how RMD rules impact them. Understanding and avoiding common RMD mistakes can help retirees potentially save money.
- Failure to account for the new RMD rules under the SECURE 2.0 Act, such as the increase in the starting age for RMDs and the need to take the total aggregated RMD from all IRAs before Roth conversions, can lead to increased tax liabilities.
- In the realm of personal finance, ignoring the RMD rules for inherited IRAs or missing the RMD deadline can result in penalties of up to 25% of the missing funds, along with regular income taxes on the undeclared distributions.
