RMD stands for Required Minimum Distribution, which refers to the minimum amount you must withdraw from your retirement accounts each year once you reach a certain age. However, not all retirement accounts are treated equally when it comes to RMDs.
Roth Accounts:
RMDs typically do not apply to Roth IRAs during the original owner's lifetime, as contributions to these accounts have already been taxed. However, different rules apply to inherited Roth IRAs, where beneficiaries must adhere to the inherited IRA rules, which are beyond the scope of this article.
Traditional IRAs and Other Retirement Accounts:
If you have a Traditional IRA, SIMPLE IRA, SEP IRA, or an employer-sponsored 401(k), you must begin taking your first RMDs by April 1 of the year after you turn 73 to avoid penalties. Subsequent RMDs must be taken by 12/31 of each year. This age threshold was updated by the IRS to 73 for those who reach that age after December 31, 2022. If you fail to take your RMD, the amount not withdrawn will be subject to a 25% excise tax (down from 50% prior to 2023).
How RMDs Are Calculated:
RMDs are calculated by dividing the fair market value (FMV) of your retirement account as of December 31 of the previous year by the distribution factor from the relevant IRS table. These distribution factors are based on life expectancy and are periodically updated to reflect changes in average life spans. You can find these tables on the IRS website or consult your account custodian, who can provide the correct RMD amount.
Deferring RMDs:
Some qualified plans may allow you to defer RMDs beyond age 73 until you retire, but this exception does not apply to plans from previous employers.
Let's break this down with an example:
Suppose you turn 73 in September this year. You are married, and your spouse, who is the sole beneficiary of your account, is 68. If you have multiple IRAs, you must calculate the RMD for each account separately. For simplicity, let's assume you have one Traditional IRA.
1. Determine the FMV: On December 31, 2024, the balance of your IRA is $250,000. This is the amount you'll use in your RMD calculation.
2. Find the Distribution Factor: Since your spouse is 5 years younger and is the sole beneficiary, you'd use the distribution factor from Table III (Uniform Lifetime Table), which is 26.5 in this case.
3. Calculate the RMD: Divide the FMV by the distribution factor: $250,000 ÷ 26.5 = $9,433.96. This is the amount you must withdraw and report as taxable income.
If you do not withdraw the required $9,433.96, you will face a 25% tax penalty on the amount not withdrawn. Additionally, RMDs could push you into a higher income tax bracket, so it's crucial to plan accordingly.
My two cents: Understanding RMDs is vital for effective retirement planning. Knowing how to calculate your RMD, when to take it, and how it impacts your taxes can help you avoid costly penalties and ensure your retirement funds are managed wisely.
At J’s Limited, we are committed to making financial education accessible to everyone. If you're seeking practical solutions for your personal or business financial needs, don't hesitate to reach out to me at jslimitedgroup@outlook.com. I'd be happy to chat!
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