One of the largest financial transitions that older adults experience is the start of required minimum distributions (RMDs) from tax-deferred retirement savings plans such as traditional individual retirement accounts (IRAs), SEP-IRAs, and qualified employer retirement savings plans (401(k), 403(b), and 457 plans and the Thrift Savings Plan or TSP for federal government workers).
Required Minimum Distributions (RMDs) are the minimum amounts that retirees must withdraw annually starting at age 73 or 75, depending on birth year. In my book, Flipping a Switch, I refer to RMD withdrawals as “the mandatory flipped switch” because they are not optional.
In addition, RMDs are taxed as ordinary income in the year they are withdrawn, which impacts older adults’ tax liability. As a result, some have a higher taxable income and/or tax bracket than they did when they were working.
Key “need to knows” about RMDs are described below:
Why RMDs Exist
When people are working, the government offers two choices:
Option A: Pay taxes now on a known current income at a known tax rate
Option B: Pay taxes later on an unknown future income at an unknown future tax rate
When people choose Option B, they elect to make RMD withdrawals in the future and gamble that they will have less income and a lower tax rate in retirement vs. working years. They also benefit from decades of compound interest on their savings.
Required Beginning Date (RBD)
- The first RMD withdrawal from traditional IRAs must begin by April 1 of the year after the year when an account owner reaches age 73 or 75. This is the required beginning date.
- The first RMD from employer plans must begin by the later of the year a plan participant turns 73 or 75 or April 1 of the year following the year of separation from service.
- The “still working exception” allows employees over 73 to delay RMDs from their current employer’s retirement plan if they are still working and don’t own the company.
Two “Crunch Times” for RMDs
- April 1- The deadline for legally postponed RMD withdrawals for older adults’ first RMD or the still working exception. If RMDs are postponed, there will be two taxable RMD distributions in the following year (current tax year and previous tax year).
- December 31- The deadline for routine annual withdrawals after the year of the first RMD. The RMD amount can be withdrawn in a single lump sum or a series of withdrawals.
RMD Calculation Method
Two pieces of information are needed to calculate the RMD withdrawal amount: the account owner’s age and the retirement account balance on December 31 of the previous year. For example, December 31, 2024 for a RMD withdrawal in 2025.
With this information, divide the retirement account’s prior year-end balance by the IRS life expectancy factor based on your age. The life expectancy-based divisors for ages 73 to 120+ are found in the IRS Uniform Lifetime Table.
Example: The divisor for age 73 is 26.5. If the prior-year account balance was $500,000, the RMD would be $500,000 ÷ 26.5 or $18,868 (rounded).
Younger Spouses
If a spouse is more than 10 years younger than the retirement account owner, and the sole beneficiary, the couple’s actual joint life expectancy can be used to calculate RMDs. The RMD amount is lower than that calculated with the Uniform Lifetime Table, which stretches out the retirement account balance over a longer period of time.
Tax Penalties
Custodians of tax-deferred retirement plans report account withdrawals to both taxpayers and the Internal Revenue Service (IRS). Therefore, the IRS can easily calculate what you owe.
The tax penalty for missing a RMD completely, or taking an insufficient RMD, is 25% of the amount that you should have withdrawn but did not. The penalty may be reduced to 10% if corrected within two years.
The IRS can enforce the penalty via collection actions such as liens, levies, or wage garnishment.
Timing RMD Withdrawals
The start age for RMDs is age 73 for older adults born between 1951 and 1959 and age 75 for those born in 1960 or later. The 10% penalty for early withdrawals goes away at age 59 ½ so withdrawals can be made prior to RMD age.
Some people need the money in their retirement accounts during their 60s while others keep their money invested as long as possible. People with large account balances may start withdrawals between age 59 ½ and 73 (or 75) to gradually decrease their account balances and spread income taxes over more years.
Combining Accounts
IRS rules allow plan participants to combine multiple traditional IRA account balances, including rollover IRAs. Account owners can then take a RMD distribution for all IRAs from only one IRA or a portion from any combination of different IRA accounts. Some people do this for portfolio rebalancing purposes. You cannot combine IRAs with other types of accounts like a 401(k).
RMD rules also allow 403(b) plan participants to combine multiple accounts and withdraw the total RMD from one or more of the accounts. 401(k) and TSP accounts cannot be combined.
What to Do With RMD Withdrawals
The short answer is “anything you want.” Specifically, this money can be spent on living expenses or “extras” (e.g., travel), gifted to family members and/or charities, or saved in a taxable account or even a Roth IRA (if you have earned income from a job or self-employment and do not exceed the annually adjusted income limits).
Income Taxes on RMDs
There is no long-term capital gains tax rate on RMD withdrawals as there is on money withdrawn from investments outside of retirement savings plans. RMD withdrawals are added to account owners’ other taxable income and taxed at the tax rate for their tax filing status (e.g., single and married filing jointly).
This can bump some older taxpayers into a higher tax bracket and trigger income tax on Social Security benefits, the IRMAA surcharge for Medicare premiums, and the net investment income tax (NIIT).
Tax Withholding for RMDs
There are four methods to make sure that enough money is withheld to pay the tax due on RMDs:
- Request tax withholding through the plan custodian
- Make quarterly estimated tax payments to the IRS ( by April 15, June 15, September 15, and January 15 of the next year)
- Over-withhold taxes somewhere else (e.g., a post-retirement job or spouse’s job)
- A combination of the above methods
“Safe harbors” to avoid an underwithholding penalty are paying the IRS at least 90% of a current year’s tax liability or 100% of last year’s tax (110% with an adjusted gross income over $150,000).
Tax-Saving Strategies
Strategies to minimize RMD withdrawals and their associated taxes include:
- Do strategic multi-year tax planning with a certified public accountant (CPA), certified financial planner (CFP), enrolled agent, or other qualified tax advisor
- Make qualified charitable distributions (QCDs) to nonprofit charities starting at age 70 ½
- Gradually make Roth conversions to reduce or eliminate traditional IRA balances
- A combination of the above strategies
RMDs for Spouse Beneficiaries
Retirement account assets pass to one or more named primary beneficiaries when an account owner dies. It is also wise to have one or more contingent beneficiaries named as “Plan B.” There are different RMD rules for spouse and non-spouse beneficiaries.
Surviving spouses can move their inherited deceased spouse’s assets into their own IRA or an inherited spousal IRA. RMDs are based on the survivor’s life expectancy.
RMDs for Non-Spouse Beneficiaries
Non-spouse beneficiaries must generally withdraw the entire account within 10 years of the original owner’s death. This is called the 10-Year Rule. Annual RMDs may be required within the 10 years if the deceased account owner died after starting RMDs.
Exceptions apply for certain eligible designated beneficiaries (e.g., disabled or chronically ill beneficiaries, minor children, and those within 10 years of the deceased’s age).
Final Thoughts
RMDs are a fact of life for many older adults. Set aside funds for taxes and decide what to do with the remainder of withdrawn funds. Again, there are three options for RMDs: spend, gift, or resave it. Use this Required Minimum Distribution Planning Worksheet to develop a personalized plan.
