As 2021 draws to a close, retirees need to conduct a year-end financial review. Much of the year-end planning process is the same whether you’re working or already retired including, reviewing income & expenses, insurance coverages, estate planning documents, and potential year-end tax-saving strategies. Reaching retirement age means adding Required Minimum Distributions to the list of things you need to plan for at year-end. Retirement accounts you’ve inherited are also subject to Required Minimum Distribution rules.
What is a Required Minimum Distribution?
Once you reach age 72, you are required to take a determined about of money out of your retirement accounts each year. There are a few exceptions to this rule for retirees. Roth accounts don’t have a required minimum distribution while the original account owner is alive. You don’t have to take money from an employer plan if you’re still working there and own 5% or less of the company.
Your retirement account’s first required minimum distribution can be delayed until April 1st of the following year. After that, required minimum distributions must be taken by December 31st of each year. Delaying your first required minimum distribution could increase your tax bracket in the following year, so it’s important to consider the tax impact before deciding to delay it.
For retirees, the required minimum distribution amount is set based on tables provided by the IRS and your account balance at the end of the previous year. For inherited accounts, the rules are more complicated. Different rules may apply depending on when you inherited the account and what your relationship was to the account holder. If you’ve inherited retirement accounts, seek the advice of a tax planner with expertise in this area.
If you fail to take a required minimum distribution, the tax penalty could be as high as 50% of the amount that should have been distributed. The severe tax penalties make it very important to keep up with your required minimum distributions.
Recent Changes to Required Minimum Distribution Rules
In 2019 Congress passed the SECURE Act which raised the starting age for required minimum distributions.
Previously, required minimum distributions started in the year you turned 70½. Starting in 2020, the age was raised to 72. If you reached age 70½ before 2020, you are currently required to take minimum distributions.
Another important rule change happened in 2020. To help retirees who were impacted by the pandemic, Congress waived required minimum distributions. If you should have taken a required minimum distribution in 2020 and didn’t, the good news is you are not subject to the normal penalty. However, the required minimum distribution rules are in effect for 2021. If you skipped your required minimum distribution in 2020, be sure to take one this year.
If you are retired or have inherited retirement accounts, it is very important to pay attention to the required minimum distribution rules. Proper financial planning can help minimize the tax impact of these distributions. Failing to follow the rules can result in substantial tax penalties. Weigh your required minimum distribution decisions carefully, and when in doubt seek the advice of a competent tax and financial planner.
Matthew A Treskovich | CFA, CPA/PFS, CITP, CMA, CFP®, AEP®, MBA, CLU, ChFC
Chief Investment Officer