Avoiding retirement account required minimum distribution mistakes

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You have about a month left to make sure you get it right when it comes to mandatory withdrawals from retirement accounts.

Required minimum distributions, or RMDs as they’re called, are annual amounts that must be withdrawn starting in the year you turn 72, starting at age 70 and a half before the Secure Act took effect in 2020. RMDs apply to 401(k) plans. both traditional and Roth, and similar workplace plans, as well as most individual retirement accounts. Roth IRAs do not have mandatory withdrawals until after the account owner’s death.

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While most retirees withdraw more than they are required to, meaning they need the income, others need to make sure they calculate their RMDs accurately and by following the different rules that apply. Getting it wrong could mean facing a 50% tax penalty on the amount that should have been withdrawn but wasn’t.

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Note that while the stock market is down this year, your RMDs are based on the balance of each qualified account on December 31 of the previous year. So for your 2022 RMDs, this means the balance at the end of 2021.

“A lot of people took a beating [in the stock market] this year, and then the question is, “Do I get a break because my balance has dropped so much?” And the answer is no,” said Ed Slott, CPA and founder of Ed Slott and Co.

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Here’s how your RMDs are calculated

The amount you must withdraw each year is generally determined by dividing the December 31st balance of each qualified account by a “life expectancy factor” as defined by the IRS.

For example, if you turned or will turn 72 this year, that number would be 27.4, according to the new IRS life expectancy tables that went into effect Jan. 1. Divide your account balance, let’s say it’s $100,000, by that. and your 2022 RMD for that account would be about $3,650. So if the balance is $500,000, your RMD would be five times, or about $18,250.

The new IRS tables reflect longer life expectancies, which means annual RMDs are generally lower (as a percentage of the balance) than they would be if the pre-2022 tables were used.

Different rules apply to different account types

Note that if you have multiple accounts subject to RMDs, you may have options.

For IRAs, you can calculate the total for each RMD and take that amount from just one of your IRAs, or any combination you like. This aggregation applies to traditional IRAs as well as SEP and SIMPLE IRAs.

“For all IRAs, you can add up all the RMDs, and then you can take that aggregate amount from any IRA or combination of those IRAs,” Slott said.

“I tell people to get rid of the smaller accounts; I say let’s empty the smaller accounts,” he said. “Having too many accounts means you’re more likely to miss an RMD from one of the accounts or lose it in your calculation.”

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Note that inherited IRAs are not included in that aggregation rule. Unless you have multiple IRAs that you inherited from the same decedent, you must take RMDs from each inherited IRA, Slott said.

For 401(k) accounts, RMDs must come from each account subject to withdrawals. However, you can aggregate 403(b) accounts, Slott said.

Avoid “pooling” income in the first RMD year

If you celebrated your 72nd birthday this year, or will do so in December, be aware that while the law allows you to delay your first RMD until April 1 of next year, doing so would mean taking two RMDs in 2023, which could have tax consequences.

“In 2023 they would ‘bundle’ income,” Slott said. “The best option for most people is to take the first RMD in 2022 and the second in 2023, in two separate tax years, and in most cases that will reduce your taxes in each year.”

Also, if you’re working and contributing to an employer-sponsored retirement plan and don’t own more than 5% of the company, RMDs don’t apply to that particular account until you retire.

Spouses cannot combine their RMDs

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Married couples must view their accounts and RMDs separately. In other words, while each person can aggregate the RMD amount between their own accounts as they allow, they cannot combine those amounts with their partner’s and then take RMDs from only one spouse’s account.

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Also, while you can delay RMDs from a 401(k) if you’re working for the company that sponsors it, you must still take those distributions from any other 401(k) accounts you have, as well as any other qualified accounts.

You can take RMDs “in kind” if you need to use stock

Having enough liquidity in your retirement account — that is, cash — to meet your RMD is the ideal scenario, Slott said. However, if you need to lean on your shares, RMDs can be taken “in kind,” he said.

This essentially involves transferring private stocks from your tax-advantaged IRA to a taxable investment account, such as a brokerage account. Although you would have paid taxes on the amount transferred, you would have taken your RMD and still owned the stock.

“You’re holding the same but you’ve satisfied your RMD,” Slott said.

A “qualified charitable distribution” can be used.

If you are charitable, you can use a “qualified charitable distribution” of up to $100,000 to satisfy your RMD. This involves transferring money directly from your account to a qualified charity and the amount is excluded from your taxable income.

For inherited IRAs, 401(k) plans, or other qualified retirement accounts, the balance must be fully withdrawn within 10 years if the owner died after 2019, unless the beneficiary is a spouse or other eligible individual .

The Security Act of 2019 eliminated the ability for many beneficiaries to extend distributions over their lifetime if the original account owner died on or after January 1, 2020.

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