Saving money in IRA and 401(k) accounts is a great way to save for retirement on a tax-deferred basis. After having gotten away without paying any taxes, there comes a time when you eventually will have to begin taking required minimum distributions from those accounts.
The reason for the withdrawal requirement is that Uncle Sam wants to finally begin collecting taxes on your retirement savings that have been able to grow for years and/or decades on a tax-deferred basis.
The rules for taking required minimum distributions have changed in the past few years. The Setting Every Community Up for Retirement Enhancement, or SECURE, passed in late 2019, raised the age to start taking the required withdrawals for those born after June 30, 1949, from 70½ to 72. When the Coronavirus Aid, Relief, and Economic Security Act, or CARES, was signed into law on March 27, 2020, it suspended required minimum distributions, also called RMDs, for everyone in 2020. However, RMDs are scheduled to resume in 2021.
As with all things involving taxes and retirement, there are some exceptions and requirements when it comes to taking required minimum distributions.
The amount of your RMD is based on your account balance and life expectancy. The amount is calculated by dividing your tax-deferred retirement-account savings as of Dec. 31, 2020, by your life-expectancy factor. For example, an individual age 75 in 2021 had a total of $500,000 in tax-deferred retirements on Dec. 31, 2020. As a result, the RMD for 2021 is $500,000 divided by 22.9 (the IRS life-expectancy factor for age 75), which equals $21,834.06.
If you’re still employed at age 72, do not own 5% or more of the company and participate in its 401(k) plan, you can delay taking your required minimum distributions from your current employer plan until you retire — as long as your employer’s plan allows it.
If a spouse is more than 10 years younger than the IRA owner and the spouse is the sole beneficiary of the IRA, the IRA owner can use the Joint Life Expectancy Table instead of the Uniform Lifetime Table, and take advantage of the lower RMDs and the reduced tax bill.
If you fail to take an RMD when required, or if you withdraw less than required, you will have to pay a 50% penalty on the amount you failed to withdraw.
If you have multiple 401(k) plans, the minimum distribution must be determined and withdrawn separately from each 401(k). This also applies to Roth 401(k)s. If you have multiple IRA accounts, the minimum distribution must also be determined separately for each IRA. However, unlike 401(k) accounts, you can add your IRA accounts together and take the total distribution from any one or more of your accounts.
One way to avoid paying taxes on RMDs is to donate them to a charity. The charity must be an IRS-qualified charity, and you can donate up to $100,000.The donation must occur via a trustee-to-trustee transfer. You cannot make a qualified charitable distribution from a SIMPLE IRA, SEP-IRA 401(k) or 403(b) plan. If you want to use the money from these accounts to make a qualified charitable distribution, you must roll these assets into a traditional IRA.
Unlike a Roth IRA, Roth 401(k)’s are subject to RMDs. To avoid the RMD on a Roth 401(k) you can rollover your Roth 401(k) to a Roth IRA. It’s important to be clear on the five-year rule and how it affects your ability to withdraw funds you roll over.
Martin Krikorian, is president of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford. He is the author of the investment books, “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Successful Investor.” Martin can be reached at 978-244-9254, Capital Wealth Managements website; www.capitalwealthmngt.com, or via email at email@example.com.