Turning 73? Required minimum distributions explained

This article will ... Outline the penalties for failing the take a required minimum distribution (RMD). Help you calculate your current year RMD.  Explain why taking your RMD during a bear market can significantly diminish your retirement savings.

If you are age 73 or older, you are required to take at least a minimum withdrawal from your tax-deferred retirement accounts every year, whether you need the money or not.

Why? The federal government wants its share.

Tax-deferred retirement accounts, such as 401(k)s and traditional IRAs, are funded with pretax dollars, yielding an immediate tax deduction in the year you contribute. They also provide the opportunity to potentially produce higher long-term returns through compounded growth, since earnings are not taxed until you distribute funds from your account.

But you can’t leave those dollars untaxed forever.

The Internal Revenue Service requires you to begin taking a required minimum distribution, or RMD, from your tax-deferred retirement account every year after you reach 73 — the new age limit under omnibus budget legislation passed near the end of 2022. (Learn more: Retirement rule changes coming in 2023)

That age limit for RMDs climbs to 75 effective January 1, 2033.

For your first distribution, you have until April 1 after the year in which you turned 73 to take your withdrawal. For all subsequent years, you must take your RMD by December 31. You can always take more than the required minimum if you choose, but any excess distribution beyond the required minimum cannot be applied to the RMD for a future year.

Distributions from tax-deferred accounts are taxed at your ordinary income tax rate, which caps out at 37 percent for the highest income households in 2024, rather than the capital gains tax rate for earnings on most assets held for more than a year, which caps out at 20 percent.

In prior years, the penalty for failure to take an RMD from a tax-deferred account by the required deadline resulted in a hefty 50 percent excise tax. But, with the recently enacted law, that excise tax drops to 25 percent, and if corrected in a timely manner, to 10 percent.

Which accounts do RMDs affect?

RMDs apply to all employer-sponsored retirement plans, including profit-sharing plans, 401(k)s, 403(b)s, and 457(b) plans, as well as traditional IRAs and IRA-based plans, such as SEP IRAs, SIMPLE IRAs, and SARSEPs.¹

RMDs do not apply to Roth IRAs, including those held inside an employer retirement plan, during the lifetime of the original owner, because contributions are made with after-tax money. Roth IRAs do not require withdrawals until after the death of the owner.

Calculating your RMD

The amount of your RMD is determined by your projected life expectancy and the size of your account.

Be aware that mandatory RMDs, when taken during a bear market, can significantly reduce your retirement savings. For example, a 74-year-old investor whose IRA assets were valued at $500,000 at year-end 2021 would have to have taken a $19,607 RMD in 2022. Had that investor taken their distribution on Jan. 1, 2022, before the markets fell, their account would have been left with $480,393. By waiting until the fall of 2022 to take their RMD, however, when the average retirement portfolio value (based on an allocation of 60 percent stocks and 40 percent bonds) was down roughly 25 percent, their IRA value would be worth $360,295, according to an analysis by Barron's.

Use the appropriate IRS worksheet to calculate your current year RMD yourself.

Or, the federal government provides an RMD calculator to help estimate your annual required minimum distribution. According to the calculator, a taxpayer aged 75 with a balance of $250,000 in their traditional IRA would be required to withdraw roughly $10,200 from their account in 2024.

If you have more than one tax-deferred IRA, you must calculate your RMD separately for each account, but you may take your minimum distribution from one or more accounts. The same is true for 403(b)s. Taxpayers who own other types of tax-deferred accounts, however, including 401(k)s and 457(b) plans, must take RMDs separately from each of their plan accounts, according to the IRS.²

Potential tax implications of RMDs

Depending on the balance in your tax-deferred accounts and your other sources of retirement income, including pensions and Social Security, the distributions you receive could conceivably bump you into a higher tax bracket. It could also potentially trigger higher taxes on your Social Security benefits and an additional high-income surcharge on your Medicare benefit.

In particular, those taking their RMD for the first time at age 73 should be aware of the potential tax implications of their withdrawal strategy.

For example, those who wait to take their first RMD until April 1 of the following year, as they are permitted to do for their first withdrawal, would also be required to take their second withdrawal by December 31 of that same year – which could potentially trigger higher taxes that year.

To mitigate their tax hit in retirement, some pre-retirees choose to begin withdrawing money from their tax-deferred accounts after they turn age 59½. (Any earlier and they would face an early withdrawal penalty.) They would still owe ordinary income tax on the distributions, but the withdrawals would slowly reduce the balance in their tax-deferred accounts, which could result in a smaller RMD when they turn 73 (or 75 beginning in 2033).

That strategy yields another important potential benefit too: It may enable you to delay claiming Social Security beyond your full retirement age, which permanently increases the size of your monthly benefit. (Learn more: Filing for Social Security retirement benefits)

Another way to potentially offset a future tax bump when RMDs kick in is to convert a portion of your tax-deferred accounts to a Roth IRA early in retirement when your tax rate may be lowest. While income limits exist for Roth IRA contributions, there are no income limits for conversions.³

Be aware that when you convert to a Roth IRA, you will owe taxes upfront on the amount you distribute from your tax-deferred account (contributions and earnings), which can amount to a sizable bill. The earnings in a Roth IRA going forward, however, will grow tax free, and your account will not be subject to RMDs, so it can continue to potentially deliver returns for longer. From an estate planning perspective, Roth IRAs can also be potentially passed along to your heirs.

Yet another option is a qualified longevity annuity contract (QLAC). It’s a type of annuity that can be bought with money from qualified retirement accounts. It provides a way to delay required minimum distributions and their associated taxes while building a plan for the possibility of living a very long life. (Related: Understanding QLACs)

These various options, however, may not be appropriate for everyone. It is important to consult a tax advisor or financial professional to help weigh the pros and cons of any strategy that could affect your financial security.

Taking your RMD

How you use your RMDs is up to you. You can spend it on current living expenses, save it, invest those dollars to chase potential stock market returns, pass it along to your heirs, or treat your family to an all-expenses paid vacation.

If you have enough savings that you truly don’t need your RMD to pay for living expenses, you might also consider donating all or part of your distribution to a favorite charity. The government allows taxpayers to gift up to $100,000 from their IRAs to a qualified charity tax free each year.⁴ The donation goes to a good cause, and the RMD does not get included in your taxable income.

Some investors also choose to be tactical with their RMDs, using their annual withdrawals to sell off portions of their portfolio that are underperforming or no longer align with their investment goals.

As with most things involving retirement planning, it is important to work with a financial professional who can help guide you in making the best decisions for your financial situation.

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