If you are retired or nearing retirement, you’ve undoubtedly heard about required minimum distributions, which are the minimum amounts you must withdraw from your individual retirement account (IRA) and other retirement accounts, like your 401(k). It’s the government’s way of making you cash in a portion of your retirement savings each year, helping to generate tax revenue for the Treasury and capping the potential growth of your tax-deferred savings accounts (unless you have a Roth IRA, which we talk about below).
We’ve seen big changes in RMD rules these past few years, first with the SECURE Act in late 2019 and then with the CARES Act in 2020. While RMDs were waived last year, it’s unlikely this will happen again in 2021. You can now wait until age 72 to start taking RMDs, but Congress is working on raising that age limit to 75. If you have inherited IRAs or are passing inherited IRAs to your beneficiaries, you’ll want to pay special attention to the 10-year distribution rule. These changes can be confusing, so we encourage you to reach out to your advisor.
Here are 5 common questions clients ask about managing their mandatory RMD withdrawals.
1) Will required minimum distributions be waived in 2021 like they were in 2020?
In 2020, the CARES Act permitted taxpayers to skip RMDs from IRAs or other retirement plans, like 401(k) or 403(b) plans, due to the COVID-19 pandemic. There is no indication that lawmakers intend to waive RMDs again in 2021, so you should assume that mandatory distributions are going to be required this year. Your 2021 RMD will be based on the account market value as of December 31, 2020 — the last day of the prior year — and the appropriate IRS life expectancy factor.1 Your account custodian should also advise you of the correct amount to withdraw for 2021 from each account.
2) At what age do I need to start taking money out of my IRA?
For years, RMDs kicked in once you turned age 70 ½. That changed in 2019 with the passage of the SECURE Act, which raised the starting age for RMDs from 70½ to 72 for all taxpayers reaching age 70½ on January 1, 2020, or later (some exceptions apply to participants in employer plans who are still working after age 72).
Congress raised the RMD age to recognize increasing life expectancies and the need for American workers to make their retirement savings last longer. In fact, the RMD age may be raised yet again. A bipartisan retirement bill being considered in Congress (but not yet approved) would raise the RMD age limit to 75, letting people grow their money for longer and delay paying taxes. Your advisor will keep you posted on any new developments.
3) I heard the RMD calculation formulas will be changing. Is that true?
That’s absolutely correct, and it is good news for retirement savers. Starting in 2022, the RMD formula is changing, making the RMD amounts smaller and allowing your money to grow tax-deferred even longer. The new RMD life expectancy tables2 issued by the IRS will take effect January 1, 2022, and will apply to all IRA, 401(k) and other retirement accounts. The new rules acknowledge that retired workers need to conserve their retirement assets in the event they live longer than anticipated.
Here’s an example of how the new formulas will lower required distributions. Assuming you have an IRA worth $300,000:
- Your RMD at age 72 is now $11,718.75 ($300,000 divided by the life expectancy factor of 25.6).
- In 2022, your RMD would drop to $10,948.91 ($300,000 divided by the new life expectancy factor of 27.4). That’s a reduction of 6.6%, allowing your retirement funds to continue growing for a longer period of time.
4) What about my inherited IRA account? Do I have to take RMDs?
It depends. If you inherited a retirement account before January 1, 2020, due to the death of the account owner, you will be required to take annual RMDs. Be aware that beneficiaries of inherited IRAs must use a different life expectancy table than original IRA account owners, which means beneficiaries must take larger distributions.
The SECURE Act also removed the stretch for inherited IRAs for retirement accounts inherited on or after January 1, 2020. So most beneficiaries can no longer stretch the distributions over his or her lifetime. Instead, a 10-year distribution rule will require all retirement assets be distributed out of the account within 10 years of the plan owner’s death, with limited exceptions. Here are some strategies to consider if you’ve been using a stretch IRA strategy to pass on your retirement assets to your beneficiaries.
5) Do I need to take RMDs from my Roth IRA?
One of the perks of a Roth IRA is that account owners are not required to take RMDs, even after reaching age 72. That means your Roth IRA can grow tax-free for years without interruption. One caveat: Special rules apply to inherited Roth IRAs. If you inherit a Roth IRA, you must make withdrawals, following the same rules that apply to traditional inherited IRAs and other inherited retirement accounts. However, since it’s a Roth IRA, distributions are tax-free.
RMD rules can be complex, and several exceptions apply. To avoid tax penalties and other costly mistakes, make sure to review your withdrawal strategy with your advisor before putting it into action.