It's that time of year to add a bit of cash to your bank account from an unexpected place: your IRA and 401(k). But why, when, and how?
Why
Once you reach the age of 72, the government flips the script on saving for retirement and begins to require disbursements. After all, they let you save tax-deferred in your pre-tax retirement accounts for decades, and now they want to receive some money!
When
The way an RMD works, also known as a Required Minimum Distribution, is that your retirement account balance on December 31st of the prior year is divided by the government's life expectancy tables. Whatever the sum of the division equals is your RMD for the year, which must be taken by year-end. Notably, those who just turned 72 have until April 1st of the following year to take their first RMD.
How
When you put money into your traditional, SEP, or SIMPLE IRA, it was made before taxes (Roth accounts do not have RMDs). Therefore, when you withdraw the funds, any amount taken out is considered ordinary income, which the government taxes if you "earn" more than the standard deduction amount.
Generally, your advisor or broker will do these calculations for you and send your RMD without fanfare. If you have a 401(k) plan, it is likely done automatically as well. The reason being is that if you fail to take your RMD, there is a 50% penalty assessed on the amount missed.
Speaking of 401(k) plans, if you have a Roth or after-tax subaccount within your plan, any RMD amounts are calculated on your total balance, not solely your pre-tax balance. Additionally, you must take an RMD from each 401(k) plan, unlike IRAs which can be lumped together.
If you do not need income, having a 401(k) RMD that draws post-tax monies or having multiple plans could warrant a conversation on the benefits and drawbacks of a rollover to an IRA.
Options
Those who do not need the income generated by their annual RMD can consider donating the money directly to a charity or reinvesting it outside of their retirement account. One creative solution is to use the RMD payment to fund 529 contributions for your grandkids!
We Are Here To Help
Lundeen Abrams Advisors has already begun calculating and processing RMDs for our clients this year and anticipate finishing these payments in the coming weeks.
If you are not a client of our firm and would like to learn more about how RMDs work, please reach out to us to set up an appointment so we can discuss your options. We will look forward to talking with you soon!