Putting money into a retirement account requires thoughtful planning. And so does taking it out. When the Setting Every Community Up for Retirement Enhancement (SECURE) 2.0 Act was signed into law in December 2022, guidelines governing distributions from 401(k)s, individual retirement accounts (IRAs), and other retirement plans changed. While the new rules have implications for nearly everyone with a retirement account, those who have already reached retirement age could see the biggest impact and may want to plan proactively to optimize their withdrawals.
What is an RMD?
Required minimum distributions (RMDs) are annual withdrawals from specific retirement accounts: profit-sharing, 403(b), 457(b), and 401(k) plans, as well as different types of IRAs (with the exception of Roth IRAs).1 IRS rules require that retirement account holders take annual RMDs, and the penalty for missing a distribution can be steep (although the SECURE 2.0 Act reduced it from 50% to 25% of the required distribution amount).
Another notable change implemented by the SECURE 2.0 Act was an increase in the age when account holders must begin taking distributions. Starting January 1, 2023, the RMD age is now 73 (up from 72). In 2033, it will increase again, to 75. Individuals who were 72 or older prior to the SECURE 2.0 Act’s passage are not affected and can continue to take RMDs as previously scheduled.
Here are a few other details about RMDs that are worth noting:
- If you’re still employed and have a 401(k) with that company (but you are not a 5% owner), you can wait until you retire to take an RMD from a 401(k).
- RMDs are required for those with inherited IRAs.
Year-one RMD
A retiree’s first distribution must occur by April 1 of the year after they reach RMD age. For example, if you turned 72 in 2022, then you must take your first RMD by April 1, 2023. After the first year, the RMD due date is December 31. Since the first RMD isn’t due until April of the following year, you have some flexibility regarding the timing of your first withdrawal, but taking two RMDs in a single year can have tax implications.
Delaying the first distribution often stems from changes in income between the first-year RMD and the second-year RMD. Examples include the sale of a house or business, employment income, and high realized capital gains. Talk to an advisor if you’re nearing age 73 and need guidance on the timing of your first RMD.
When should I take an RMD?
There’s no fixed rule for when you should take an RMD during the calendar year; you have the flexibility to decide for yourself or with your advisor. Some opt to take an RMD at the beginning of the year to help fund their living costs or to cover a large expense. By taking the distribution early, you can check the obligation off your to-do list, at least until the following year.
You can also take an RMD in installments, or over the course of a year. This can be a good option if you prefer to receive a monthly “retirement paycheck” rather than an annual distribution (akin to a pension or an annuity). You can also withhold taxes from your RMD, to avoid a higher tax bill in April.
Some prefer to wait until later in the year to take an annual distribution because laws are subject to change at any time. For example, the benefit of waiting was highlighted in 2020, when the CARES Act waived the distribution requirement for that year. Anyone who’d already taken their annual distribution had to decide whether to keep it or go to the trouble of returning it to their retirement account. Another reason to wait until later in the year is to gain a sense of your overall tax liability and use the distribution to pay some of the estimated tax. You can withhold up to 100% of a distribution for tax purposes.
How to use an RMD
You can deposit an RMD in a checking or savings account if you intend to use it for cash flow or large expenses. If you have sufficient cash flow, you can deposit the funds into a taxable investment account, allowing you to reinvest those funds in the market. Folks over age 70½ can also make a qualified charitable distribution (QCD) and move a portion of the RMD (up to $100,000) to a qualified charity.
As with most financial planning, the timing of taking an RMD can be complicated and contingent on the larger context of an individual’s financial situation. The important thing is to remain proactive, making sure to avoid a steep penalty for not taking a required distribution. If you’d like advice on the timing of taking an RMD under the new rules, view our resources page here, or reach out to your advisor to discuss your options.
As a financial planning expert with a deep understanding of retirement accounts and the regulatory landscape, I can confidently delve into the intricacies of the SECURE 2.0 Act and its implications for retirement planning.
Firstly, the Setting Every Community Up for Retirement Enhancement (SECURE) 2.0 Act, signed into law in December 2022, brought significant changes to the guidelines governing distributions from retirement accounts. One of the key aspects affected by the SECURE 2.0 Act is the Required Minimum Distributions (RMDs).
Required Minimum Distributions (RMDs) are annual withdrawals mandated by the IRS from specific retirement accounts, including profit-sharing, 403(b), 457(b), and 401(k) plans, as well as various types of IRAs (excluding Roth IRAs). The consequences for missing an RMD can be severe, with penalties reduced from 50% to 25% of the required distribution amount by the SECURE 2.0 Act.
A pivotal change introduced by the SECURE 2.0 Act is the increase in the age at which account holders must start taking RMDs. Starting January 1, 2023, the RMD age is raised to 73, up from the previous age of 72. Furthermore, this age will increase to 75 by 2033. Importantly, individuals aged 72 or older before the SECURE 2.0 Act's enactment remain unaffected and can adhere to the previous RMD schedule.
Several nuances regarding RMDs are worth noting:
-
Employment Status and RMDs: If still employed and holding a 401(k) with the company (not a 5% owner), one can delay taking an RMD until retirement.
-
Inherited IRAs: RMDs are required for those with inherited IRAs.
-
Year-One RMD: The first distribution for a retiree must occur by April 1 of the year following reaching RMD age, with subsequent RMDs due by December 31.
-
Flexibility in Timing: While the first RMD can be delayed until April of the following year, taking two RMDs in a single year can have tax implications, necessitating careful planning, especially if there are changes in income.
Regarding the timing of RMDs, individuals have flexibility. Some opt to take RMDs at the beginning of the year to fulfill living costs or cover significant expenses. Others prefer installment payments throughout the year, akin to a monthly retirement paycheck. Waiting until later in the year allows individuals to assess potential law changes and understand their overall tax liability.
In terms of utilizing an RMD, options include depositing it in a checking or savings account for cash flow, putting it into a taxable investment account for market reinvestment, or making a qualified charitable distribution (QCD) to a qualified charity for individuals over age 70½ (up to $100,000).
In conclusion, the SECURE 2.0 Act has reshaped the landscape of retirement planning, particularly concerning RMDs. The key is proactive planning and understanding the nuances to avoid penalties and optimize withdrawals under the new rules. For personalized advice on navigating these changes, individuals are encouraged to consult with financial advisors or explore available resources.
