What’s New, 72? How the Rules of Required Minimum Distributions Changed

It’s a good idea, no matter your age, to have a tax-advantaged retirement plan in place to provide financial security when you retire. This plan could take the form of an Individual Retirement Account (IRA), which allows you to make tax-deferred investments, or a 401(k) plan through an employer, which allows you to contribute a tax-deferred portion of your wages to an individual account (and, ideally, have your employer match it).

But you can’t keep funds in your retirement account indefinitely; the IRS will eventually want the tax bill settled after you begin making withdrawals. An exception is a Roth IRA, in which contributions are taxed and withdrawals are tax-free; the IRS will allow you to keep that money in your Roth account during your lifetime. Another option is a Roth 401(k)—an employer-sponsored retirement savings account that is funded with post-tax money—but these accounts have the same mandatory withdrawal rules as a traditional 401(k), even though the money taken out is tax-free.

These mandatory withdrawals for IRAs, 401(k)s, and Roth 401(k)s are known as Required Minimum Distributions (RMDs): amounts established by the IRS that must be taken out of retirement accounts annually once you reach a certain age. As of now, RMDs start at age 72 (or 70½ if you reached 70½ before January 1, 2020).

Yes, 72 Is the New 70½

The SECURE Act of 2019 changed the age at which individuals must begin taking withdrawals from their retirement accounts. (The acronym stands for Setting Every Community Up for Retirement Enhancement, because Congress likes legislative initials to spell a word.) Before the SECURE Act, anyone turning 70 on or before June 30, 2019, was required to start taking RMDs for the year in which they reached the age of 70½. However, under the SECURE Act, if a person’s 70th birthday is July 1, 2019, or later, they now do not have to take their first RMD until the year they reach age 72.

All RMDs will be included in your taxable income except for any portion that was taxed previously or that can be received tax-free, such as with a Roth 401(k). These RMDs are designed to eventually exhaust the funds in the account so that the accumulations won’t last forever.

You can withdraw more than the minimum required amount. Your withdrawals will be included in your taxable income except for any part that was taxed previously or that can be received tax-free (such as qualified distributions from designated Roth accounts).

What to Do at 72

If you are turning 72 this year and taking your first RMD, you have until April 1, 2022, to do so. For each subsequent year, your RMD must be taken by December 31 to avoid a 50% penalty. Keep in mind, if you delay your initial RMD until April 1, you’ll be responsible for two withdrawals that year (one by April 1 and one by December 31), which could result in a larger tax liability. If you’re older than 72, you must take your RMD by December 31 each year.

As noted, Roth IRA owners do not need to take RMDs during their lifetimes, but any beneficiaries who inherit Roth IRAs must take RMDs. If you are inheriting a Roth IRA, your RMD would be calculated as outlined below.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 temporarily waived the RMD rules for 401(k) plans, individual IRAs, and inherited IRAs and the 10% penalty on early withdrawals up to $100,000 from 401(k)s for 2020. It also waived 2019 RMDs due by April 1, 2020, for individuals who turned 70½ in 2019 and didn’t take their RMDs before January 1, 2020. Under the CARES Act, account holders were able to repay the distributions over the next three years and to make extra contributions for this purpose. These measures applied to anyone directly affected by COVID-19 or who faces economic hardship due to the pandemic. There is no longer an RMD waiver, as the CARES Act expired on March 14, 2021.

What About Inheritors?

In 2020, the Internal Revenue Service began requiring most new inheritors who aren’t spouses or minor children of the deceased to empty the inherited retirement account over 10 years, rather than continuing to allow those inheritors to stretch out withdrawals over their own expected lifetimes. The IRS, however, didn’t indicate whether these inheritors had to make a minimum withdrawal each year, and many people were confused about whether they had to take annual amounts.

In May of 2021, however, the IRS made a rule revision to clarify that, while the new 10-year rule stays in effect, taking an annual RMD during those 10 years is not required. The inheritor can withdraw the full amount in the first year or even wait until the 10th year, thus giving the assets more time, potentially, to grow. The new 10-year rule applies regardless of whether the participant dies before, on, or after, the required beginning date, now age 72.

Inheritors won’t owe taxes on withdrawals from a Roth IRA so long as the original owner held the account for at least five years. But the inheritor will owe taxes on withdrawals from a traditional IRA.

The rules for how IRA beneficiaries must take RMDs depend on when the original account owner passed away and their relation to the original owner. For example:

• Generally, non-spouse beneficiaries who inherit an IRA from someone that passed away in 2020 or later may be required to withdraw the entire account balance within 10 years.
• Spousal beneficiaries and certain eligible non-spouse beneficiaries may be permitted to take RMDs over their life expectancy.

What If You Don’t Need the RMD?

RMDs are designed to spread out your retirement savings and related taxes over your lifetime. If you don’t depend on the money to satisfy your spending needs, you may want to consider the following ideas.

• Reinvest your distributions in a taxable account to take advantage of continued growth. You can then add beneficiaries to that account without passing along future RMDs to them.
• Use a strategy made possible by the qualified charitable distribution (QCD) rule, which allows traditional IRA owners to deduct their required minimum distributions on their tax returns if they give the money to a charity. The QCD strategy allows you to send payments directly from your IRA to the charities of your choice and have it count towards your RMD. This means that the charitable giving out of your IRA reduces your adjusted gross income, taxable income, and the resulting tax liability. It’s important to note that this special treatment does not apply if you receive the RMD and later decide to donate the cash to charity. Additionally, the maximum that you can transfer is capped at $100,000 per person per year.

How Are RMDs Calculated?

Calculating RMD amounts can get a bit complicated, which is why we recommend leaving it to the experts. But here’s an overview of how it works.

RMD amounts are determined by looking at the following factors:

• Your age as of December 31 of the current year and your corresponding life expectancy factor according to the IRS Uniform Lifetime Table—or the Joint Life and Last Survivor Table if your spouse is your sole beneficiary and more than 10 years younger than you.
• Your retirement account balance as of December 31 of the previous year, which should be adjusted to include any outstanding rollovers or asset transfers that weren’t in the account at year-end.

Conclusion: When in Doubt, Ask

When and how to take your RMDs can be confusing. Seeking help from a financial adviser is always a good idea. Together, you can evaluate and readjust your retirement plans in accordance with these changes.

If you like reading our “Bowen Reports Blogs”, Bowen Asset does have a Facebook page: https://www.facebook.com/BowenAsset Please check it out as we frequently make comments on the page about not just finance and economic events that happen in between our blogs.