Understanding required minimum distributions

If you’re approaching retirement–or already there–you should be aware of recent changes to the rules surrounding required distributions from retirement accounts. Following these changes can save money and avoid frustration.

Research reveals that women and men who reach the age of 73 can expect to live another 14 and 12 years, respectively^†. Such longevity underlines the importance of preparing for life after work, including regular funding of retirement accounts.

What are required minimum distributions?

Reaching age 73 is a financial milestone for those who have certain retirement plans. U.S. tax law requires account holders to begin annually withdrawing from a retirement account by April 1, of the year after they turn 73^‡. That amount is called a required minimum distribution (RMD). There are special exceptions for Roth IRAs, which have no RMD during the owner’s lifetime, and for company retirement plans when someone is continuing to work and they and their family do not own 5% or more of the company. In such cases, RMDs would not start until after they retire.

Recent legislation, called the SECURE 2.0 Act of 2022, increased the RMD starting age to 73 for this year, and ultimately will raise it to age 75 starting in 2033. The law also decreed that starting in 2024, Roth accounts that are not IRAs are treated like Roth IRAs and will not require withdrawals until after the death of the owner. Remember that beneficiaries of Roth IRAs and other Roth accounts are subject to the RMD rules. Roth IRA earnings will be tax-free for as long as you live, assuming you meet the minimum requirements when they’re withdrawn. SECURE 2.0 Act RMD rules, most of which became effective in 2023, apply to the following accounts:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k) plans
• 403(b) and 457(b) plans
• Profit sharing plans
• Other defined contribution plans
• Roth IRA beneficiaries

If you withdraw more than the minimum, the extra amount will not apply to the next year’s RMD.

How do I calculate my required minimum distribution?

Usually, the financial firm that held the retirement account at the end of the year will provide a report by January 31 of the year in which the RMD must be withdrawn. They must either provide the amount in that report or offer to calculate the amount to withdraw.

Those who inherit an IRA are responsible for calculating the RMD amount themselves. The Secure and Secure 2.0 acts may have complicated matters. Certain ‘eligible designated beneficiaries’ are still able to calculate an RMD by dividing the prior December 31 balance of that IRA or retirement plan by a life expectancy factor that the IRS publishes in Tables in Publication 590-B.

These ‘eligible’ beneficiaries are surviving spouses, disabled or chronically ill beneficiaries, those who are not more than 10 years younger than the decedent, and children of the owner who are under age 21. Although, the latter must have the entire account withdrawn by the end of the year they reach age 31.

The Secure Act now places a 10-year outer limit on this deferral for most other beneficiaries (called ‘designated beneficiaries’), with a complicating factor being whether the owner died before or after their required beginning date.

If a non-qualifying trust or estate is a beneficiary, the rules are even more complex and different–the funds may be forced out of such accounts in as few as five years in many cases and must use the decedent’s date of birth for calculating RMDs in other cases.

Because calculating the amount of an RMD for inherited accounts can be very complicated, and because the account owner is ultimately responsible for the accuracy of the amount to withdraw, feel free to ask your Huntington Private Bank Advisor for help.

What happens if I don’t withdraw?

Failing to withdraw any or all of your RMD may now result in a penalty of 25% (down from 50% prior to 2023) of the required amount not withdrawn. This penalty could be reduced to 10% if paid during a certain length of time, called a ‘corrections window.’

Proposed regulations issued in 2022 have added an additional situation in which the IRS will automatically waive the penalty. If someone dies in a year in which they failed to take an RMD, the beneficiaries must take it by the end of the year. However, if they manage to take the decedent’s unwithdrawn RMD by the time their tax return is due (generally April 15, or October 15 with a six-month extension, or sometimes the first business day after that date), the IRS will automatically waive the penalty.

Are required minimum distributions taxed?

Typically, contributions to whatever account the RMD is coming from would have been tax deferred, not tax free. Therefore, in most cases, RMDs are considered as 100% ordinary income for tax purposes. Again, Roth IRAs are slightly different. All distributions are tax-free provided the Roth account has been open for at least five years and the owner is older than 59½. If it has not been open for five years, there are still generally taxpayer-favorable rules in determining what portion is taxable and when.

Taxpayers who make non-deductible contributions to IRAs or other non-Roth retirement plans create an exception where the basis (original contribution) is not taxed, because the taxpayer did not get a tax deduction on that original contribution. For example, if someone contributed $6,000 that was non-deductible to a traditional IRA that grows to $9,000 by the time it is later withdrawn, the $3,000 of gain would be ordinary income and the original $6,000 would be a non-taxable return of basis.

We’re Here to Help

Required minimum distributions apply to most retirement accounts, but the amount that must be withdrawn might be difficult to figure out for some, especially when trusts and estates are involved as beneficiaries. Your Huntington Private Bank Advisor, along with your tax and legal advisors, can help determine that amount and help decide how those funds can continue to be put to good use.

Sometimes it can even make good financial and tax sense to take more than the required minimum distribution, depending on the taxpayer’s individual situation. To learn more, please contact your Huntington Private Bank team to see how we can help or find a Huntington Private Bank office near you.