By John Grace
After years of saving in your pre-tax retirement accounts, you have a dependable nest egg to provide lifetime income after you make work optional.
You took advantage of time and tax-deferred growth, meaning you may have 30% more money set aside than if the funds had been taxed yearly. But the IRS will not allow you to keep that money untouched.
Your financial advisor and tax professional have encouraged you to contribute to your retirement accounts regularly. But some professionals consider such accounts as “tax-infested investments” because you have entered the twilight zone of required minimum distributions where you must take money out of your retirement account every year for the rest of your life, no matter what has happened to your account value.
Whether you need the money or not, the withdrawals are required, are 100% taxable, start modestly and increase yearly for the rest of your life. At 73, the withdrawal rate is below 4%, and for those who get to 80 and beyond, the rate is north of 10%.
As the name suggests, the amount is minimal and you can always withdraw more. You can also withdraw funds from accounts and invest the money elsewhere before your required minimum distributions age to reduce the amount you must take out later.
The age at which you must start withdrawing required minimum distributions from tax-advantaged retirement accounts depends on when you were born. Check out the table below to see when you need to start taking them.
If you were born before July 1, 1949, your required minimum distributions age is 70 ½.. If you were born Between July 1, 1949 and Dec. 31, 1950, your required minimum distributions age is 72. If you were born between Jan. 1, 1951 and Dec. 31, 1956, your required minimum distributions age is 73.
If you were born between Jan. 1, 1957 and Dec. 31, 1959, your required minimum distributions age is 74 and if you were born after Jan. 1, 1960, your required minimum distributions age is 75.
Before 2019, your required minimum distributions began in the year you turned 70 ½. In 2019, the Secure Act raised the required minimum distributions age to 72. The Secure Act 2.0 raised the required minimum distributions age again, based on your birthday, as indicated above.
Retirement plans that have required minimum distributions include traditional IRAs, simple IRAs, and traditional 401(k), 403(b) and 457(b) accounts, as well as profit-sharing plans.
The deadline for taking your required minimum distributions each year is Dec. 31. You can delay taking your first required minimum distribution until April 1 of the year after you turn your required minimum distributions age.
The penalties for not taking required minimum distributions are steep. If you do not withdraw the necessary required minimum distribution by Dec. 31 or take less than is required, you may have to pay a 50% excise tax on the amount that wasn’t distributed as required.
Required minimum distribution are not required for Roth accounts.
There is no way to avoid paying income tax on withdrawals from traditional retirement accounts. Roth individual retirement accounts offer several key benefits, including tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions.
One key disadvantage: Roth IRA contributions are made with after-tax money, meaning there’s no tax deduction in the years you contribute.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) and SECURE 2.0, passed in 2022, may make Roth conversions more attractive for some people. Under the SECURE Act, most IRAs inherited by beneficiaries (other than spouses, disabled or chronically ill individuals, those less than 10 years younger than the IRA owner, or other limited exceptions) must be fully distributed within 10 years of the original owner’s death.
That income could push some beneficiaries into higher tax brackets. Therefore, a Roth conversion could be attractive if those beneficiaries’ tax rates are higher than the rate upon conversion. In addition, the starting age for required minimum distributions was increased from 70½ to 72 in 2019, then moved again to age 73 in 2022. SECURE 2.0 also provides that the required minimum distribution age will be extended to age 75 in 2033.
These changes may allow individuals more time to execute a conversion strategy, according to T. Rowe Price, a firm that manages money for many large investors.
As you plan your financial success, secure assistance to run your numbers and evaluate different scenarios as needed. Analyze situations where a Roth conversion may make sense and consider making the tax bite less odorous.
John Grace is a registered representative with LPL Financial. His On the Money column runs monthly in The Wave. The opinions expressed here for general information only and are not intended to provide specific advice or recommendations for any individual.
There is no way to avoid paying income tax on withdrawals from traditional retirement accounts.