Evolving Rules for RMDs
There are several key “milestone” ages in later life. At age 50, you can make catch-up contributions to individual retirement accounts and tax-deferred retirement savings plans, like 401(k)s. At age 62, you can start receiving Social Security (but with a lower benefit than waiting until full retirement age or FRA) and, between ages 66 and 67, current workers will reach FRA and claim full benefits. A final age-related milestone is taking required minimum distributions or RMDs at age 72.
RMD rues have changed twice within the last five months, including a change made in response to COVID-19 related investment volatility . Below is a description of RMD basics and the two recent rule changes:
¨ Definition- RMDs are a requirement to withdraw a certain percentage of money (based on age) from tax-deferred retirement savings accounts. Minimum withdrawals are based on the previous year’s ending values of those accounts and the IRS uniform distribution table. There are specific RMD rules for surviving spouses and children of account owners.
¨ Taxation– Withdrawals from pre-tax-dollar savings plans (i.e., accounts where taxes are not paid on the contributed amount) are taxed as current (a.k.a., ordinary) income. Examples of pre-tax plans are traditional IRAs, SEP-IRAs, 401(k)s, 403(b)s, and the Thrift Savings Plan or TSP.
¨ Tax Penalty- The penalty for failing to withdraw the correct RMD amount by the deadline is 50% of the amount that should have been taken out but was not. For example, a $1,000 penalty if you were supposed to withdraw $2,000.
¨ Calculation- To determine the RMD amount, divide the tax-deferred account balance on December 31 of the previous year by the distribution period divisor corresponding to your age. For example, the multiple at age 72 is 25.6. Someone age 72 who has $500,000 in a 401(k), for example, would need to take an RMD of at least $19,532 ($500,000 ÷ 25.6).
¨ Traditional IRAs– If you have multiple accounts, determine a separate RMD for each IRA, total the RMD amounts, and take a withdrawal from any one or more accounts. You cannot aggregate RMDs, however, for employer-sponsored plans.
¨ Rule Change #1 (SECURE Act)- The age to start taking mandatory RMD withdrawals was changed from age 70½ to age 72 beginning in 2020. The required beginning date for the first RMD is April 1 of the year after the year that people turn 72 (note: delaying will result in taking an age 72 RMD and age 73 RMD in one year, which can impact income taxes and Medicare Part B and D premiums). For all subsequent years, RMDs must be made before December 31.
¨ Rule Change #2 (CARES Act)- Due to extreme stock market volatility related to COVID-19, which could have forced retirees to withdraw assets during a downturn, RMDs were suspended for 2020. This includes RMDs that were pushed back from 2019 to April 1, 2020. Voluntary account withdrawals are allowed, however, as well as qualified charitable distributions (QCDs) that can be transferred directly from a traditional IRA to a qualified charity at age 70½ or older.