(This article originally appeared in the February 2023 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)
Retirement savers squirrel away money into retirement accounts for decades, and with the power of compounding, these accounts can provide their owners with bountiful nest eggs for their later years. But eventually Uncle Sam is ready for those savers to start taking out some of their nest egg’s yield and give him his share.
As you near your 70s, you need to be prepared for when required minimum distributions from your retirement accounts kick in. “The RMD is something the government plans for us — on their schedule, not yours,” said Maggi Keating, CFP®, a financial planner at FBBCapital Partners and the spouse of a retired Marine Corps colonel.
Many savers have amassed hefty pretax retirement account balances, and RMDs are calculated off those balances.
“These distributions are becoming more sizable, and becoming more of a tax issue,” said Keating.
RMDs could spike you into a higher tax bracket as they add to your ordinary taxable income, which may already include military retirement pay and Social Security, among other sources of retirement income. Plus, if you fail to take out the right amount, you can incur a penalty from the IRS.
“It’s really expensive to not be aware of them,” said Tim Steffen, CPA/PFS, CFP®, director of tax planning for Baird, a wealth management firm.
Understanding the rules for RMDs not only helps you avoid trouble with the IRS, but that knowledge can also present strategic opportunities to make the most of your nest egg, and in some cases, even keep your tax tab to Uncle Sam in check.
The First RMD
The federal government previously raised the starting age for RMDs to age 72 from age 70½, and the new SECURE Act 2.0 law further raises the age original owners of retirement accounts must begin taking RMDs.
No matter the starting age, for your first RMD only, you get an option to delay taking it. You can take the first RMD by the end of the year in which you reach RMD age. Or you can wait to take it until April 1 of the year following that birthday (that April 1st is known as your required beginning date, or RBD).
But then “the problem is you have to take two in one year,” said former Capt. Keola Elobt, USA, MBA, AIF, a West Point graduate who is now the group head of MAI Retirement at MAI Capital Management. If you delay your first RMD, you also have to take your second distribution in the same year. The second and all subsequent RMDs must be taken by Dec. 31 of each year.
Consider how doubling up your RMDs might affect your tax bill. If doubling pushes you into a higher tax bracket, you might want to forgo delaying and take the first RMD in the year you reach RMD age.
[MARCH 7 MOAA WEBINAR: What SECURE Act 2.0 Means for Your Retirement]
To calculate each RMD, divide the account balance as of Dec. 31 of the previous year by an IRS distribution period factor (found in life expectancy tables in IRS Publication 590-B) based on the age you will turn on your birthday in the current year.
Note that new life expectancy tables went into effect for 2022, said Eric Bronnenkant, CPA, CFP®, head of tax at financial firm Betterment. “On average, it increases life expectancy by about two years,” he said.
Let’s say you turned age 72 in 2022 and your IRA was worth $1 million at the end of December 2021. You consulted Table III (Uniform Lifetime), and divided your prior year account balance by 27.4 — the factor for age 72. Your first RMD would have been $36,496, regardless of whether you took it in 2022 or chose to delay it until April 1, 2023.
Your second RMD would use the account value as of Dec. 31, 2022, and the distribution period factor for age 73, which is 26.5. Say your IRA grew back to $1 million by year-end 2022. Your second RMD would be $37,736. (Even with SECURE Act 2.0, people who turned 72 in 2022 still must take their first RMD by April 1, 2023.)
You’ll want to see if spreading those two RMDs over two years is more advantageous for you, instead of taking the total of the RMDs in one tax year, or vice versa. If your income will be lower in the second year, doubling up might not be an issue.
Note that you can always take more money out than the RMD, but don’t take less. If your RMD is $30,000, but you only take out $10,000, for instance, you would be subject to a penalty of a percentage of $20,000 you didn’t take. The new SECURE Act 2.0 law reduces the penalty from 50% to 25%. That penalty goes down to 10% if you correct the failure to take an RMD in a timely manner.
Be sure to check where April 1 falls on the calendar. Steffen warns that this deadline may not extend if the date falls on a weekend or holiday, like the regular federal tax return deadline of April 15 does. In 2023, the federal tax deadline shifts to April 18 for most federal taxpayers. “But April 1 in 2023 is a Saturday, and it’s unclear if you would get an extension to April 3,” Steffen said. “It’s best to plan early and not push the deadline.”
Original owners of retirement accounts are subject to RMDs from traditional IRAs and employer-sponsored retirement accounts, such as Thrift Savings Plans and traditional 401(k)s. RMDs also apply to Roth TSPs and Roth 401(k)s, although that will go away in 2024 as a result of the SECURE Act 2.0 law. For traditional tax-deferred retirement accounts, you’ll owe ordinary income tax on the RMD.
Roth IRAs do not have RMDs for original owners; the money can sit in that account growing tax free for as long as you like. Another wrinkle: If you hold multiple traditional IRAs, you need to calculate the RMD amount for each one, but you can take the total amount out of just one IRA. If you hold multiple employer-sponsored retirement accounts, you need to calculate and take an RMD out of each account.
You can opt to take your RMD in a series of installments. Some people like to take monthly or quarterly withdrawals; others like to take the RMD out all at once. You can choose to take it all out early in the year, or later in the year. But don’t wait until the last minute — consider taking your full RMD no later than early December to allow time for any custodian hiccups.
Smart RMD Moves
Delving further into the rules may give you opportunities to maximize your nest egg. The following moves can help take the sting out of RMDs.
Continue working. More Americans are working longer these days, and it’s not uncommon for seventysomethings to be in the workforce. If you are still working past RMD age and are not a 5% owner of the company, you can push off RMDs from your current employer-sponsored retirement account until the year you fully retire. But Steffen notes you need to work the whole year.
“You can’t work just one day and skip the RMD,” he said. If you plan to retire at the end of the year, he said, “Don’t retire December 31. Retire January 1.”
Let’s say you retired in early January 2023 at the age of 75. You had delayed RMDs from your employer plan because you were working. But even though you missed your original start date based on age, you still have the option to delay your first RMD from the employer plan until April 1 following the year you stopped working. So while that first RMD is for 2023, you could wait until April 1, 2024, to take it.
But be aware that working doesn’t push off your RMDs from traditional IRAs. You must start taking those once you hit the age threshold, regardless of employment. There is a workaround, though: If your current employer allows you to roll traditional IRA money into your employer-sponsored retirement account, you can roll in the money to avoid RMDs until you retire.
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Give to charity. If you are charitably inclined, a qualified charitable distribution, or QCD, may be a good fit for you — and it can cut your tax bill, too. Starting at age 70½, an IRA owner can give up to $100,000 a year directly to charity from their IRA. The QCD amount is not taxable, even for taxpayers who take the standard deduction. If you no longer itemize, QCDs can be a great way to give to charity and still get a tax break.
Once you hit your RMD age, there’s an even bigger bang for the buck. A QCD can do double duty as your RMD. So instead of having taxable RMD income, the QCD will satisfy your RMD free of tax.
“It is not considered income at all,” said Keating. Just be sure to take a QCD first, because once you are subject to RMDs, the first dollars that come out of your account each year are considered to be part of your RMD until the full amount is taken. So if your RMD is $30,000, make sure you do a QCD before you take that full amount out; you could do a QCD of $30,000, for instance, and satisfy your RMD all at once, or do a QCD of, say, $10,000 and then take out the remaining $20,000 to satisfy the rest of your RMD. If you take out your full RMD first, you can still do a QCD, but it won’t pull double duty as your RMD.
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Do an in-kind transfer. Even when the market is down, typically you must still take your RMD. But if you like the investments in your retirement account and don’t need the cash to live on, ask your account custodian to transfer shares “in kind” to a taxable brokerage account in an amount that is equivalent to your RMD amount.
You still pay ordinary income tax on your RMD, but moving the shares to a taxable brokerage account gives them the opportunity to grow when the market bounces back. Your basis in the shares will be their value on the date of transfer.
After shares are transferred in kind, be sure that the closing price of the trade equaled or exceeded your RMD. If not, transfer more shares or cash from your retirement account to fully meet your RMD amount for the year.
Avoid paying twice. If you stashed nondeductible contributions into your IRA, you can get a tax break when money is withdrawn. Ideally, you kept good track of your nondeductible contributions on Form 8606 over the years, which documents the basis. “It’s entirely up to the taxpayer to track what is tax-free,” Steffen said.
When you distribute money from the retirement account, you can use the pro rata rule so you don’t pay tax on those nondeductible contributions twice.
“When you withdraw the RMD, part of it will be nontaxable,” said Bronnenkant.
For instance, let’s say $50,000 of a $500,000 IRA are nondeductible contributions, or 10%. If your RMD is about $20,000, $2,000 — 10% of the RMD — would be tax free, and you would pay ordinary income tax on the remaining 90%.
Every year, you recalculate the amount of nondeductible contributions left and apply the new percentage to your distribution. Be aware that if you hold multiple traditional IRAs, you must figure out the ratio of all your nondeductible contributions to your IRA balances in total.
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Factor in your spouse’s age. Minding the gap can pay off when it comes to RMDs and younger spouses. If you are hitting RMD age but your spouse is more than 10 years younger and the sole beneficiary, you are eligible to take out less since your spouse has a longer life expectancy. In this situation, the account owner can use Table II (Joint Life and Last Survivor Expectancy) in IRS Publication 590-B to calculate the RMD.
Let’s say you turn 74 in 2023, and your spouse turns 62. Using both of your ages in 2023 when consulting Table II, you find the factor to divide your account balance is 27.0. For a $1 million IRA, your RMD would be $37,037. If you had to use the factor based on only your own age, your RMD would be about $2,179 higher.
Consider a Roth conversion. One thing you can’t do with an RMD is convert it to a Roth — the IRS doesn’t allow it. But after you take your RMD, you can convert any or all of the remainder of your traditional retirement account to a Roth IRA.
Keep in mind that a Roth conversion will add to your taxable income for that year. But any money converted to the Roth would no longer be subject to RMDs for the original owner of the account, and a partial conversion reduces the amount left in the traditional IRA — a reduced balance lowers future RMDs.
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