You likely have a lot of things to do between now and the end of the year. Your calendar is probably filling up with holiday shopping, charitable giving, and get-togethers with family and friends. But for older taxpayers with one or more tax-advantaged retirement accounts—as well as younger taxpayers who’ve inherited such an account—there may be one more critical item to check off the list before December 31: Taking your required minimum distributions (RMDs).
While it might not be as festive as wrapping gifts, ensuring your RMDs are handled correctly is essential for your financial health. Let's break down why this matters and how to handle it efficiently.
When applicable, RMDs usually must be taken by December 31. This isn't a deadline you want to miss. If you fail to take the full amount required, you could face a penalty equal to 25% of the amount you should have withdrawn but didn’t.
For example, if your RMD was $10,000 and you forgot to take it, you could owe the IRS $2,500 just for the oversight. While the penalty can drop to 10% if the failure is corrected in a "timely" manner, even 10% is a cost worth avoiding. It is always best to take your distributions on time to keep your money in your pocket.
Generally, RMD rules kick in after you reach age 73. At that point, you must take annual distributions from your traditional (non-Roth) accounts, including:
There is an exception for 401(k)s if you are still an employee and not a 5%-or-greater shareholder of the employer sponsoring the plan.
A Note on Deferrals: If it is your first year taking an RMD, you might have the option to defer it. However, be careful with this strategy—deferring the first year means you will have to take two RMDs the following year, which could push you into a higher tax bracket.
If you have inherited a retirement plan, the rules get a bit more complex. Whether you need to take RMDs depends on several factors:
Unlike your own retirement accounts, RMD rules for inherited plans generally apply to both traditional and Roth accounts. If you aren't sure where you stand with an inherited plan, it is best to consult with us directly to avoid any surprises.
A common question we hear is whether you should take out more than the minimum.
Generally, taking no more than your RMD is advantageous because it allows the remaining funds to continue growing tax-deferred. However, sound strategy isn't always one-size-fits-all. Taking a larger distribution in a year where your tax bracket is lower might save you tax in the long run.
Before making that move, consider the potential ripple effects. A larger distribution could:
Also, remember that while retirement plan distributions aren't subject to the additional 0.9% Medicare tax or 3.8% net investment income tax (NIIT), they are included in your modified adjusted gross income (MAGI). This means they could trigger or increase the NIIT because the thresholds for that tax are based on MAGI.
The rules surrounding RMDs can be confusing, particularly when dealing with inherited accounts or strategic tax planning. If you are subject to RMDs, it is important to accurately calculate your obligation for the current tax year to avoid penalties.
At SD Mayer & Associates, we believe financial clarity empowers better decisions. We can help ensure you are in compliance and help you strategize the most tax-efficient way to handle your distributions. Please contact us today to ensure your year-end checklist is complete.