Financial Advice

| APTOS LIFE MARCH 16, 2022 10

RMDs: Tricky but Critical

Most people have a general understanding that the money they have been keeping tax deferred in retirement accounts is going to eventually be subject to certain withdrawal requirements, and applicable taxes owed will need to be paid at that time. What causes a lot of confusion is when withdrawals need to start and how to calculate them. Required Minimum Distributions (RMDs) refer to the minimum amount that a retirement account owner must begin withdrawing from their various retirement accounts at a certain age in order to satisfy IRS requirements. The rules surrounding RMDs can be complex and have changed over the last few years. Let’s take a closer look at a few of the updates and changes that have taken place since the passage of the SECURE Act at the end of 2019.

When Do RMDs Generally Start?

Prior to the passage of the SECURE Act, RMDs were generally required to begin when you reached age 70.5 (I’m still trying to figure out why they thought using a half age was a good idea). With the passage of the SECURE Act, those who turned age 70 on July 1, 2019 or later could defer taking their first RMD to age 72 (those who turned 70 before July 1, 2019 still needed to use the old rules of starting RMDs at age 70.5).

While your first RMD generally will come due in the year you turn 72, the IRS allows a special one-time provision for your first RMD only. Let’s look at the example of Bob, who turns 72 in 2022. Bob could opt to take his applicable first RMD in calendar year 2022, or he could wait and opt to take his first RMD by April 1 of the year following the year he reaches 72 (in this case it would be by April 1, 2023). Again, this is a one-time deferral for your very first RMD only. However, there is a caveat to waiting until April 1st of the following year. Bob would need to take 2 RMDs in 2023—one by the April 1st deadline for the RMD that he was subject to in 2022, and the second by Dec. 31, 2023, for the RMD that he is subject to in 2023. The amounts required to be withdrawn will be different as well for the RMD due in April and RMD due in December. Each year thereafter, the deadline for Bob to withdraw his RMD annually is Dec. 31. The penalty for not withdrawing your RMD is steep, at 50% of whatever amount wasn’t withdrawn but should have been.

If you are still working at age 72, you may be able to defer taking an RMD from the retirement plan in which you are an active participant in until the year you retire (or are terminated). I emphasize may because there are a few considerations here. One is that it must be a qualified employer sponsored plan (i.e. 401k, 403b, or other defined contribution plans, but not IRAs). Secondly, you must be an active participant in the qualified company plan, and the plan must allow for it. Thirdly, you cannot own more than 5% of the business. Let’s look at another example with Bob. Bob is turning age 72

in 2022, but he is still working for ABC, Inc. and participates in their 401k plan. He is not an owner of the company. Bob also does freelance work on the side and contributes to a SEP IRA based on the income he generates from his freelance work. Lastly, Bob also has an old 401k from when he worked for XYZ Company years ago, but is no longer an active participant in the plan since he no longer works for XYZ Company. Bob would need to begin taking RMDs from his SEP IRA and old 401k from XYZ Company Soren E. Croxall with no exceptions in 2022 (or

Financial Advice opting to wait until April 1, 2023 under the one-time first RMD provision). Since he is still an active employee with ABC, Inc. and not an owner, Bob may be able to defer needing to take RMDs from the ABC, Inc. 401k plan until the year he retires (or terminates his employment with ABC) under the “still working” exception. He would need to check with his HR Department or his 401k plan sponsor to see if he qualifies. As you can see, there are a lot of nuances as to when RMDs must begin, depending on your situation. If you are unsure, it's best to discuss with a qualified professional as the penalty for mistakes is very steep.

How to Calculate Your RMD

Calculating your RMD from regular retirement plans and accounts (not inherited accounts, which we aren’t going to get into in this article, or Roth IRAs, which generally aren’t subject to RMDs) is pretty cut and dry. You divide the Dec. 31 retirement account value for the prior year by an age factor based on the age you will be at the end of the current year. You may be asking, “What is an age factor?” The IRS has tables that we utilize when calculating distributions from retirement accounts and inherited accounts have a corresponding factor for each age.

An important update for 2022 is that the IRS has updated the tables (Uniform, Single Life, and Joint Life) to address the fact that people are living longer. The new age factors for 2022 result in smaller distribution requirements than under the previous tables that were in effect until the end of last year. This will allow people to keep more of their account tax deferred for longer, and also help potentially lower their overall tax burden.

Keep in mind that while it’s nice to know the general process of how to calculate RMDs, it's probably prudent to work with a qualified professional to help you avoid costly mistakes. You can also ask the custodian of your account to calculate your RMD each year, as well as help you distribute the withdrawal.

While the rules can seem confusing at times, the key thing to remember is that in general you must begin taking some money from most of your tax deferred retirement accounts at age 72. You may be able take money earlier (generally after age 59.5 with no penalty), but you generally must start by age 72.

Soren Croxall, CFA, CFP® is a registered representative of LPL. Financial Securities and Advisory Services offered through LPL Financial, member FINRA/SIPC, a Registered Investment Advisor. LPL Financial and Croxall Capital Planning do not provide tax or legal advice. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.