Like most industries, financial planning has its fair share of jargon and acronyms. These are commonplace for those of us working in the industry, but it can be like a foreign language to clients. I thought I would use a Friday letter every couple of months to explain some of the more common abbreviations in our world. 

First up is the abbreviation RMD, which stands for Required Minimum Distribution. RMDs have been in the news lately due to changes with the recent tax bill (SECURE 2.0). But what exactly is a RMD, and what might it mean for you? In essence, RMDs are a way for the IRS to ensure that taxes, eventually, get paid for money contributed to tax-deferred retirement accounts. Instead of allowing that money to grow tax deferred indefinitely, there is a trigger for when and how much money must be distributed. 

Accounts that fall under RMD rules:

• Traditional IRAs
• Rollover IRAs
• SIMPLE IRAs
• SEP IRAs
• Most small-business accounts (Keoghs)
• Most 401(k) and 403(b) plans
• Inherited IRAs (including Inherited Roth IRAs)

When do RMDs begin?

Starting in 2023, RMD requirements start in the year you turn age 73. On January 1, 2033, the threshold age for RMDs will rise again to 75. 

RMDs are an annual requirement once you begin taking them. For the first year only, you can delay until April 1^st of the following year. For example, if you turn 73 in 2023, you will technically have until April 1, 2024 to take your RMD. Just keep in mind you will still have a RMD the following year, so delaying the first year will cause you to double up.

Even if you are still working at age 73, you are required take a RMD from any IRAs. However, you may qualify for an exception from taking RMDs from your current employer-sponsored retirement account, such as a 401(k) or 403(b), if you’re still working and you do NOT own more than 5% of the business. 

How much is the RMD?

The exact distribution amount changes from year to year and is based on your life expectancy. It is calculated by dividing an account’s year-end value by the estimated remaining years of your lifetime, in a table provided by the IRS. The most common table is the Uniform Lifetime Table, although in certain circumstances other tables are used. The custodian (Fidelity) calculates the RMD early in January and the amount is shown on monthly statements.

What if I inherit an IRA?

Inherited IRAs are subject to RMDs, but the rules vary with your relationship to the original owner and when the account was inherited. Due to changes in recent legislation, this area has become more complex, and we look at each account individually to make sure requirements are met. Oddly enough, inherited Roth accounts are treated like inherited IRAs, unless they are inherited by a spouse or other exempted class of persons. Even though there is generally no tax due if the ROTH has existed for more than 5 years by the original owner, the account is not permitted to grow indefinitely.

What happens if I do not take my RMD?

Penalties are steep for missed RMDs, which is why we jump on them early in the year to make sure everything is in order. The good news is that the SECURE 2.0 lowered the penalty for failing to take RMDs on a timely basis from 50% of the undistributed amount to 25%.

Does this matter for people in their 30s and 40s with many years until retirement?

We find it is helpful to understand the concept of RMDs when you are young and are aggressively saving in tax-deferred accounts. It is helpful to understand that one day, in the future, these funds will need to come out of the account and will be subject to ordinary income taxes. Therefore, we advise not to “put all your eggs in one basket” and diversify retirement savings into different types of accounts. Non-Inherited Roth IRAs and regular investment accounts are not subject to RMDs and provide additional tax flexibility in retirement. 

We’d love to hear from you – let us know if there is any jargon or abbreviations you would like covered in a future article.

Mary McCraw, CFP®

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