You likely have a lot of items on your to-do list as the year winds down—holiday shopping, charitable giving, and family gatherings. But for older taxpayers and those who have inherited retirement savings, one task is critical to address before the ball drops: Taking your Required Minimum Distributions (RMDs).
Failing to withdraw the necessary amount from your retirement accounts on time can lead to substantial penalties from the IRS. Here is a clear breakdown of who is subject to RMD rules and why timely compliance is non-negotiable.
Why the RMD Deadline is Critical: Understanding the Penalties
For most account owners and beneficiaries, your annual Required Minimum Distribution (RMD) must be taken by December 31st.
If you fail to comply—meaning you don’t take your RMD, or you withdraw less than the required amount—you can face a significant excise tax penalty of 25% of the amount you should have withdrawn but did not.
While the penalty is generally reduced to 10% if the failure is corrected in a “timely” manner (typically by the end of the second year after the RMD was due), even a 10% tax is a costly mistake. The simplest and best solution is always to calculate and take your RMD on time.
Who is Subject to Annual Required Minimum Distributions?
The rules for RMDs depend on whether you are the original owner or a beneficiary, and the type of account you hold.
RMD Rules for Original Account Owners
After you reach the required beginning age, you must generally take annual RMDs from your Traditional (non-Roth) IRAs and Defined Contribution Plans (like 401(k) and 403(b) accounts).
- The RMD Starting Age: The age at which you must begin taking RMDs is currently age 73.
- The First RMD Exception: While subsequent RMDs are due by December 31st of each year, you have an exception for your very first RMD. You can defer this initial distribution until April 1st of the year following the year you turn age 73. Be aware that taking this deferral means you will have to take two RMDs in that following year—one for the prior year (due April 1st) and one for the current year (due December 31st).
- The “Still Working” Exception: If you are still employed, you may be able to delay RMDs from your current employer’s 401(k) plan until you retire, unless you are a 5%-or-greater shareholder of the company.
RMD Rules for Inherited Retirement Accounts
The rules for inherited IRAs and retirement plans (including both traditional and Roth accounts) are complex and depend on several factors, particularly the owner’s date of death and your relationship to them.
Important Note: If you inherited an account from an owner who had already begun RMDs, you are typically required to continue taking annual distributions under the 10-year rule, with the entire account emptied by the end of the tenth year. If you have inherited a retirement plan and are unsure if an RMD is required this year, it is crucial to seek professional guidance immediately.
Should You Take More Than the Required Minimum Distribution?
Generally, taking no more than your RMD is advantageous because it allows your retirement savings to continue growing on a tax-deferred basis for as long as possible.
However, there may be strategic reasons to take a larger-than-required distribution in a specific year. This strategy can be helpful if you anticipate being in a lower tax bracket this year compared to future years.
Three Key Tax Considerations Before Taking a Larger Distribution
Before withdrawing more than your RMD, you must consider the ripple effects on your total income and benefits. A larger distribution could:
- Cause Social Security Payments to Become Taxable: Higher Adjusted Gross Income (AGI) can increase the percentage of your Social Security benefits subject to tax.
- Increase Income-Based Medicare Premiums (IRMAA): Your distribution could push your Modified Adjusted Gross Income (MAGI) above the threshold, resulting in higher Medicare premiums and prescription drug charges two years from now.
- Reduce or Eliminate Tax Breaks: Certain tax benefits have income-based limits. A significant distribution could reduce or eliminate your eligibility for these breaks.
Keep in mind that while retirement plan distributions are generally not subject to the 3.8% Net Investment Income Tax (NIIT), they are included in your Modified Adjusted Gross Income (MAGI), which is the base for determining the NIIT thresholds.
Get Your RMD Calculated Today
The RMD rules are confusing and constantly evolving, especially those involving inherited accounts. Getting the calculation right is essential to avoid the steep 25% excise tax.
If you are subject to RMDs for this year, we can help you accurately calculate your required withdrawal and ensure you remain in full compliance before the December 31st deadline.
Contact us today to schedule your year-end RMD compliance review!