Unpacking the Complex Regulations Regarding Mandatory Withdrawals from Retirement Funds

 

Unpacking the Complex Regulations Regarding Mandatory Withdrawals from Retirement Funds

This year, a perplexing tax requirement has become even more complex due to the new age for required minimum distributions (RMDs) from retirement accounts. Many older adults are unaware that they must begin withdrawing money from their retirement accounts in their early 70s and pay income taxes on those funds. This is the government's way of collecting taxes on retirement savings that have been growing tax-deferred for decades.

The confusion arises not only from the requirement itself but also from the shifting age at which it begins. For years, the RMD age was set at 70 ½, but changes in recent legislation have altered this timeline. The Secure 1.0 law of 2019 pushed the age to 72, and Secure 2.0 in 2022 raised it to 73, effective this year. Further changes are on the horizon, with the age set to increase to 75 starting in 2033.

Juan C. Ros, a financial advisor at Forum Financial Management in Thousand Oaks, Calif., notes, "We always get questions about this, and especially now because the age has increased two times now in four years."

Secure 2.0 provided a temporary reprieve for individuals turning 72 this year, allowing them to delay their first RMD until April 1, 2025. First-time RMD takers have traditionally had until April 1 of the following year to make their withdrawal, while others must fulfill their annual RMD requirement by year-end.

In summary, these changes affect those born in 1951 or later. Baby boomers born between 1951 and 1959 must start their RMDs at age 73, whereas those born in 1960 or later will face an RMD age of 75.

Brokerage firms typically keep track of legislative changes and advise affected clients on their annual RMD amounts, but there's a catch. Stacy Miller, a certified financial planner in Tampa, warns that brokerages are only aware of the money you have with them. Since RMD calculations are based on your total balance across all retirement accounts subject to the requirement, individuals with funds spread across multiple firms must perform this calculation themselves or seek assistance from an advisor.

Miller points out, "The custodian doesn't know about the other accounts, and the advisor might not know either."

Failing to withdraw RMDs can result in a penalty equal to 25% of the amount not taken (reduced from 50% pre-Secure 2.0), with the possibility of a 10% penalty reduction if the account owner promptly resolves the issue by taking the required amount.

For those who don't need their RMD for living expenses, there's an option to make a tax-free charitable donation of up to $100,000 (or up to $200,000 for a married couple filing jointly) to fulfill the RMD requirement. This qualified charitable distribution (QCD) is transferred directly from an individual retirement account to a qualifying charity and doesn't count toward the donor's taxable income. This can be beneficial for higher earners as it can help prevent them from moving into a higher tax bracket or paying income-adjusted Medicare premiums.

Notably, the age for QCDs remains at 70 ½ and hasn't been adjusted to align with the RMD age changes. This divergence adds to the confusion surrounding RMDs but also creates planning opportunities, as noted by Laura Jansen, a senior wealth advisor with Ironwood Investment Counsel in Scottsdale, AZ. Some clients have chosen to start their QCDs at 70 ½ to proactively reduce their IRAs and future RMDs while making charitable donations.

Laura Jansen remarks, "These changes were made, I think, to give more flexibility, but whenever there's change, even good change, it can cause confusion."