Click Here for A Video on RMD's
RMD stands for Required Minimum Distribution. This is a value given by the IRS that determines the minimum amount of money one has to withdraw from their taxable retirement account each year.
Many times when working with clients we get asked why they have to withdraw a certain dollar amount so we wanted to discuss the reasoning behind this and why it is important to always ensure you are taking your RMD.
When you contribute to an account like your Traditional IRA or Traditional 401(k) your contribution goes in on a pre-tax basis. This means that the amount that you are contributing gets deducted from your annual income that year.
Let’s say you make $100,000 a year. You contribute $5,000 to your Traditional IRA. Your taxable income for the year would go down to $95,000. By doing this, you may have a lower tax bill for the year and also be able to save up money for retirement. As an FYI, current contribution limits for 2024 to an IRA are $7,000 with an additional $1,000 catch-up if you are over the age of 50. For a 401k, contribution limits are $23,000 with an additional $7,500 catch-up if you are over the age of 50.
However, since you technically haven’t paid taxes on those contributions, you will eventually have to. Once you reach the age of 59 ½ you can start to take penalty free withdrawals from your retirement accounts. If you take any non-qualified withdrawals before age 59 ½ you will be hit with a 10% tax penalty on them. When you take those withdrawals from your Traditional IRA or 401k, you will be taxed at your current income level.
This is one of the key differences between a Roth retirement account and a traditional retirement account. In a Roth retirement account, since your contributions were made with after tax dollars, all withdrawals after you reach the age of 59 ½ are tax free.
Now, let’s move onto why there are Required Minimum Distributions for your taxable retirement account. When you reach a certain age, in the year 2024 it is 73, the IRS requires you to start withdrawing money from your retirement account. Due to the fact that you have been able to take advantage of not paying taxes on the money that you are using for retirement in these accounts, the IRS wants to ensure that you eventually do pay that tax at some point in your life.
So, let’s talk about how your calculate your RMD each year. Straight from the IRS website “Generally, a RMD is calculated for each account by dividing the prior December 31 balance of that IRA or retirement plan account by a life expectancy factor that the IRS publishes…”*
As mentioned above, it is important once you do hit your RMD age that you start to take out the required minimum amount each year. If you fail to take the full amount, the remaining balance that is not withdrawn is subject to a 50% excise tax. With the new Secure 2.0 laws set in place, the excise tax rate drop to 25% or possibly even 10% if the RMD is corrected within 2 years.*
Now what happens if you pass on before your account is fully liquidated? Depending on your beneficiaries of the account, whether it is a spouse or non-spouse, they may be subject to what is called the “10-year rule”. That rule essentially states that the beneficiary has 10 years to fully withdraw all of the funds in the account to avoid any further tax penalties.
The Final Word:
You always want to ensure that you are taking your RMD each year to avoid any penalties. We would always suggest speaking with your tax and financial professional to help you with tax planning for your RMD’s each year. This can help to bring you confidence in your retirement planning and help to ensure that you are taking the right amount each year.
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Source: * Required Minimum Distribution (IRS)
Disclaimer:
Rockline Wealth Management (RWM) is a registered investment adviser located in Plainview, NY. RWM is registered with the U.S. Securities and Exchange Commission. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission.
Rockline Wealth Management does not offer tax or legal services. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change.
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