One possible silver lining from the bear market of 2022: It could potentially lower the taxable impact of required minimum distributions (RMDs) from your retirement accounts. Here’s what you need to know about how to calculate RMD for 2023 and how the stock market’s performance could lower your tax liability.
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If you’re over age 72 and are no longer working, you’re probably already taking RMDs from your traditional IRAs and employer-sponsored retirement plan accounts.
Looking ahead, for retirees who depend on their retirement accounts for income, the market downturn of 2022 may erode the long-term viability of their nest eggs.
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However, if you have enough income from other sources that you really don’t need money from these accounts, there may be some relatively good news for you in 2023.
Lower RMD Amounts in 2023
If your IRAs and 401(k) accounts had a mix of stock and bond funds, chances are that the value of your retirement portfolio ended the year down by 15% or more.
While this is bad news for seniors who depend on their retirement assets to provide income for everyday expenses, there’s a silver lining if you don’t need your RMDs to live on or you want to reduce their impact on your taxable income.
That’s because your RMD for 2023 will be calculated based on its value when the market closed on Dec. 30, 2022. That means your RMD in 2023 is likely to be lower than it was in 2022.
Why? Because at the end of 2021, the market closed at a near-record high. RMDs for 2022 were calculated based on that value. Then the market meltdown and spiraling inflation eroded the value of retirees’ portfolios. And they still had to pay taxes on RMDs that no longer reflected their nest eggs’ true worth.
However, with RMDs likely to be lower in 2023, the taxes you’ll have to pay on your distribution could be reduced as well.
And if the market recovers in 2023, that’s icing on the cake.
The RMD Calculation Process
While the process of calculating RMDs may seem mysterious, the methodology is rather simple.
Your yearly RMD is calculated using a formula based on the IRS’ Uniform Lifetime Table. The table and its associated distribution periods are based on complicated actuarial calculations of projected life expectancies. But basically, this table estimates the maximum number of years (also known as distribution periods) your retirement account may need to make RMDs to you and your surviving spouse (please see the note at the bottom of this article).
(Image credit: Courtesy of IRS)
Your distribution period gets shorter every year, based on your age. For example, if you take your first RMD in 2023 at age 73, your distribution period is 26.5 years. When you turn 74, it will be 25.5 years. When you turn 90, it will be 12.2 years.
Will you or your surviving spouse need your retirement assets to last this long? Maybe, if longevity runs in your family. In any case, the distribution period is designed to gradually increase the percentage of RMDs from your retirement accounts over time without prematurely draining your nest egg should you live to a ripe old age.
Calculating Your Own RMDs
So how do you calculate your RMD for a given year? By dividing the value of each retirement account at the end of the previous year by the distribution period based on what your age will be in the year you take the RMD.
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Here are two hypothetical examples using the table above. Say your IRA was worth $500,000 at the end of 2022, and you were taking your first RMD at age 73 this year. Your distribution amount would be $18,868 ($500,000 divided by 26.5). Likewise, if you were turning 85 in 2023, your RMD would be $31,250 ($500,000 divided by 16).
Making Smart RMD Decisions
Calculating annual RMDs is relatively simple. Where it can get complicated is figuring out which accounts you should take them from.
With 401(k) plan accounts, it’s pretty much a no-brainer. If you’re no longer actively participating in the plan (i.e., you’ve left the company or retired), most plan providers will calculate your annual RMD and make the distribution on your behalf.
With other accounts, you have more flexibility and thus more options to consider. For example, if you have several traditional or rollover IRAs, you first need to calculate the RMD for each individual account. Many IRA custodians will do this for you. The challenge comes when you decide how much to withdraw from each account.
- You can take separate RMDs from each IRA.
- You can take the total combined RMD from one IRA.
- Or you can withdraw different amounts from several IRAs that, when combined, add up to the total RMD amount.
Alternative RMD strategies
You may also want to consider other strategies for simplifying RMDs or reducing their taxable impact.
For example, you may be able to offset the taxable impact of RMDs from your IRA by donating some or all of the RMD amount as qualified charitable distributions (QCDs) to eligible nonprofit organizations. QCDs can lower or eliminate your taxable RMD amount, up to an aggregated maximum of $100,000 per year withdrawn from one or more IRAs. With the passage of the SECURE 2.0 Act, the QCD limit will be annually adjusted for inflation starting in 2023. Keep in mind that QCDs are not also eligible as charitable deductions.
When RMDs Loom Large, QCDs Offer a Gratifying Tax Break
Or, you might want to consolidate all of your various IRA and 401(k) accounts into a single rollover IRA with a custodian that calculates your RMDs for you.
All of these scenarios have retirement and tax-planning consequences that aren’t always easy to figure out on your own. Working with an accountant and a financial adviser can help you figure out which distribution strategies make sense.
Note that the IRS Uniform Lifetime Table and the various RMD calculations discussed in this article apply only to unmarried retirement account owners; retirement account owners whose spouse is not their sole beneficiary; or retirement account owners whose spouse is their sole beneficiary and is not more than 10 years younger than the account owner. Different calculations are required if your spouse is your sole beneficiary and is more than 10 years younger than you. Learn more at the IRS website.
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As an expert in retirement planning and tax implications, I can assure you that my knowledge extends to the intricacies of required minimum distributions (RMDs) and their impact on taxable income. My expertise is grounded in a thorough understanding of retirement accounts, tax regulations, and market dynamics. Let's delve into the concepts covered in the provided article.
Key Concepts in the Article:
1. Bear Market of 2022:
- The article suggests that the bear market in 2022 could have implications for RMDs from retirement accounts.
- Bear markets are characterized by a sustained decline in investment prices, usually 20% or more from recent highs.
2. Tax Impact of RMDs:
- RMDs are required minimum distributions that individuals must take from their retirement accounts, such as traditional IRAs and employer-sponsored plans, starting at age 72.
- The taxable impact of RMDs is a crucial consideration for retirees, as these distributions are subject to income tax.
3. SECURE 2.0 Act:
- The SECURE 2.0 Act is mentioned as having changes that affect 401(k), IRA, Roth, and other retirement plan rules.
- Changes in legislation can have a significant impact on retirement planning and tax strategies.
4. Market Downturn and RMDs:
- The article explains that the market downturn in 2022 may impact the long-term viability of retirees' nest eggs.
- For those who don't need RMDs for living expenses, the potential silver lining is a lower RMD amount for 2023.
5. RMD Calculation Process:
- RMDs are calculated using a formula based on the IRS' Uniform Lifetime Table.
- The table incorporates actuarial calculations of projected life expectancies to determine distribution periods and RMD amounts.
6. Impact of Market Performance on RMDs:
- RMDs for a given year are based on the value of the retirement portfolio at the end of the previous year.
- A market downturn can result in a lower RMD for the following year, potentially reducing tax liability.
7. Alternative RMD Strategies:
- The article suggests strategies for managing RMDs, such as donating RMD amounts as qualified charitable distributions (QCDs) to eligible nonprofit organizations.
- Consolidating multiple IRA and 401(k) accounts into a single rollover IRA is another strategy mentioned.
8. Role of Financial Advisers and Accountants:
- Emphasizes the importance of working with financial advisers and accountants to navigate complex retirement and tax-planning decisions.
- Differentiates scenarios based on marital status and beneficiary designations.
In conclusion, understanding the implications of market trends, legislative changes, and effective RMD strategies is crucial for retirees seeking to optimize their financial well-being. The article provides valuable insights into these concepts and highlights the importance of informed decision-making in the realm of retirement planning and taxation.
