What are Required Minimum Distributions (RMDs) and how do they work?

If you’re like many people in their working years, you may regularly contribute to your retirement accounts to build your savings for the future. An important thing to remember is that once you reach a certain age, you will be required to start taking withdrawals (also known as required minimum distributions, or RMDs) from certain accounts and pay income taxes. We’ll look at RMD rules, how to avoid unnecessary penalties, and ideas for making the most of this income.

RMD rules

RMDs apply to qualified retirement savings accounts, which are funded with pre-tax earnings and have an account value that can grow on a tax-deferred basis. Accounts that require RMDs include:

• Traditional individual retirement accounts (IRAs)
• Employer-based retirement plans (401(k), 403(b), etc.)
• SEP IRA
• SIMPLE IRA
• Profit-sharing plans
• Employee stock ownership plans (ESOPs)
• 457(b) plans if money is deferred on a pre-tax basis

According to IRS rules¹, you must take your first required minimum distribution for the year in which you reach age 72 (73 if you reach age 72 after Dec. 31, 2022.) “You can withdraw more than the minimum amount if you so choose,” share Tyler De Haan, Certified Financial Professional and Director of Advanced Sales at Sammons Financial Group. “Just remember that your withdrawals are commonly included in your taxable income. “

RMDs and annuities

Some annuities are housed within a retirement account. In this case, you will be required to follow RMD rules. However, if your annuity is held in a Roth IRA, which is not subject to RMDs, you will not be required to withdraw annually.

How to calculate RMDs

RMDs vary from person to person, and your annual payment will be determined based on your age, account balance as of December 31st, and life expectancy factor published by the IRS uniform life expectancy table.

You want to ensure you take RMDs each year or you could be subject to a 25% tax penalty if you fail to pay the minimum amount on time. If you pay as soon as possible, this tax penalty may be reduced to 10%. “Though there may be benefits to delaying RMDs to age 73 and 75 after Secure 2.0’s passage. It may make distributions larger and increase the amount of taxable income in later years of retirement,” adds De Haan. “This is one of the reasons why it is important to evaluate your financial plan to help minimize taxation throughout your entire retirement to make sure there are no unintended consequences.”

Like many tax-related issues, RMDs can be complicated, so talk to your tax advisor or financial professional before making any decisions. They can help you calculate your minimum distributions and discuss ways to minimize the impact of your RMDs.

Using your RMD money

Even if you do not need the income from your RMDs, you are still required to take them from qualified retirement accounts by April 1st, following the year you turn the specified RMD age. After that year, you are then required to take the RMD every year thereafter by December 31st. While you must take these annual withdrawals, you can choose how this money is used. Here are some ideas for making the most of these funds:

Share with family

Consider gifting your money to a child or grandchild. Just remember that gift tax limits may apply. Consult with your tax advisor to understand the best way to gift your family money.

Create an emergency fund

If you haven’t created an emergency fund or need to rebuild your current reserve, now could be a great time to save some money for a rainy day.

Give to charity

Perhaps you have a non-profit organization or charity you are passionate about and want to donate your RMD. This is considered a qualified charitable distribution (QCD) and will not be taxed up to $100,000. De Haan emphasizes, “the QCD must be sent directly to a 501(c) charity and you cannot take receipt of the funds.” Talk to your tax advisor to learn more about RMDs and charitable giving.

Reinvest your distributions

If you do not need the money from your retirement accounts, you could consider reinvesting your withdrawals in a taxable investment account to grow your savings for the future potentially.

Pay for tuition

With the cost of tuition rising, you may decide you would like to help pay for your grandchild’s college education. You may be able to pay tuition directly to the school or contribute to a 529 college savings plan.

Treat yourself

If you do not need your withdrawals to help with everyday expenses, you could put your money toward a home renovation, a new car, or a dream vacation.

Qualified Longevity Annuity Contract

You could also purchase a qualified longevity annuity contract (QLAC) within the retirement account, which lowers your RMD calculation going forward but requires you to begin a taxable income stream from the QLAC annuity at age 85 at the latest.

Throughout the years, you work hard to set aside some of your earnings to build your savings for the future. Understanding RMDs, how to calculate them, and ways to avoid penalties can help you make the most of this money. Consider meeting with your tax advisor and financial professional to discuss how to minimize taxes in retirement and create a financial strategy that works for you.

¹ IRS, Retirement Plan and IRA Required Minimum Distribution FAQs, irs.gov

Neither North American nor any financial professionals acting on its behalf should be viewed as providing legal, tax, or investment advice. Please rely on your qualified tax professional.

The term financial professional is not intended to imply engagement in an advisory business in which compensation is not related to sales. Financial professionals are independently contracted with North American Company and are insurance licensed that will be paid a commission on the sale of an insurance product.

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