How to avoid mistakes with required minimum distributions from your retirement accounts

You have about a month to make sure you get it right when it comes to mandatory retirement account withdrawals.

Required Minimum Distributions, or RMDs as they are known, are annual amounts that must be withdrawn from the year you reach age 72 – from age 70.5 before the start of the Secure Act in 2020. RMDs apply to 401(k) plans — both traditional and Roth — and similar workplace plans, as well as most individual retirement accounts. Roth IRAs do not require withdrawals until the account holder dies.

While most retirees withdraw more than they are required to, i.e. they need the income, others need to ensure that they calculate their RMD accurately and follow the different rules that apply. Getting it wrong could mean facing a 50% tax penalty on the amount that should have been withdrawn but wasn’t.

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Be aware that even if the stock market is down this year, your RMDs are based on the balance of each eligible account as of December 31 of the previous year. So for your 2022 RMDs, that means the 2021 year-end balance.

“A lot of people took beatings [in the stock market] this year, and so the question is, ‘Am I getting a break because my balance has gone down so much?’ And the answer is no,” said Ed Slott, CPA and founder of Ed Slott and Co.

The amount you must withdraw each year is generally determined by dividing the December 31 balance of each eligible account by a “life expectancy factor” as defined by the IRS.

For example, if you have reached or will turn 72 this year, that number would be 27.4, according to the new IRS life expectancy tables that went into effect January 1. Divide your account balance – let’s say it’s $100,000 – by this factor and your 2022 RMD for this account would be approximately $3,650. So if the balance is $500,000, your RMD would be five times that, or about $18,250.

The new IRS tables reflect longer life expectancies, which means annual RMDs are generally lower – as a percentage of your balance – than they would be if the pre-2022 tables were used.

Be aware that if you have multiple accounts subject to RMDs, you may have options.

For IRAs, you can count the total of each RMD and withdraw that amount from just one of your IRAs, or any combination you choose. This aggregation applies to traditional IRAs, as well as SEP and SIMPLE IRAs.

“For all IRAs, you can add up all the RMDs, and then you can take that aggregate amount from any IRA or a combination of those IRAs,” Slott said.

“I tell people get rid of the small accounts — I say dump the small ones,” he said. “Having too many accounts means you are more likely to miss an RMD from one of the accounts or miss it in your calculation.”

Note that legacy IRAs are not included in this aggregation rule. Unless you have multiple inherited IRAs from the same deceased, you should take RMDs from each inherited IRA, Slott said.

For 401(k) accounts, RMDs must come from each account from which withdrawals are made. However, you can aggregate 403(b) accounts, Slott said.

If you celebrated your 72nd birthday this year, or will do so in December, be aware that while the law allows you to defer your first RMD until April 1 next year, that would mean taking two RMDs in 2023 – this which could have tax consequences.

“They would ‘bundle’ revenue in 2023,” Slott said. “The best option for most people is to take the first RMD in 2022 and the second in 2023, in two separate tax years, and in most cases this will lower their taxes each year.”

Also, if you work and contribute to an employer-sponsored pension plan and own no more than 5% of the business, RMDs do not apply to that particular account until you retire.

Married couples should view their accounts and RMD separately from each other. In other words, although each person can aggregate the RMD amount between their own accounts as permitted, they cannot combine these amounts with those of their partner and then take the RMDs from only one spouse’s account.

Also, while you can delay RMDs from a 401(k) if you work for the company sponsoring it, you still need to take those distributions from other 401(k) accounts you have, as well as from any other eligible account.

Having enough liquidity in your retirement account — that is, cash — to satisfy your RMD is the ideal scenario, Slott said. However, if you need to rely on your equity holdings, RMDs can be taken “in kind”, he said.

This essentially involves transferring particular stocks from your tax-efficient IRA to a taxable investment account, such as a brokerage account. While you would pay taxes on the transferred amount, you would have taken your RMD while still owning the stock.

“You’re holding the same thing but you’ve satisfied your RMD,” Slott said.

If you are charitable, you can use a “qualified charitable distribution” of up to $100,000 to meet your RMD. This involves transferring money directly from your account to a qualifying charity, and the amount is excluded from your taxable income.

For inherited IRAs, 401(k) plans, or other qualified retirement accounts, the balance must be fully withdrawn within 10 years if the owner died after 2019, unless the beneficiary is the spouse or other eligible person .

The Secure Act of 2019 eliminated the ability for many beneficiaries to extend lifetime distributions if the original account holder died on or after January 1, 2020.