Understanding Required Minimum Distributions (RMDs)

Tax Strategies | by Jules Buxbaum | Tuesday, February 04, 2025

Required Minimum Distributions (RMDs) can make or break a retirement plan if overlooked. They dictate how and when you must withdraw funds from tax-deferred retirement accounts, and skipping them can result in big penalties.

Whether you’re nearing retirement or already there, understanding these RMD rules helps curb unexpected tax bills. For additional tax insights, consider our guide to minimizing taxes on retirement income.

What Are Required Minimum Distributions?

RMDs refer to the smallest amount you’re legally required to withdraw from certain retirement accounts each year once you reach a specific age. These accounts include traditional IRAs, 401(k)s, 403(b)s, and similar plans funded with pre-tax dollars.

The key point is that RMDs force retirement savers to start drawing down—and paying taxes on—money that has been growing tax-deferred. Even though you can always take more than the required minimum, failing to meet the yearly threshold can lead to harsh penalties.

Key RMD Rules You Should Know

Legislation has changed the RMD age in recent years. The SECURE 2.0 Act raised the age to 73 for those born in 1951 or later, and it will increase to 75 in 2033 for people born in 1960 or after.

Older rules set the first RMD at age 70½, then later at 72. Now, if you turn 73 in 2024, your first RMD deadline is April 1 of 2025. Each subsequent RMD must be taken by December 31 each year thereafter.

RMD Calculation Basics

The formula involves dividing your account balance (as of last December 31) by a life expectancy factor from the IRS Uniform Lifetime Table. This table updates occasionally, reflecting longer average life spans.

The older you get, the lower your life expectancy factor. For instance, a 73-year-old looks to a factor of 26.5. If your IRA balance was USD 265,000 at the end of last year, your RMD would be 10,000 dollars (265,000 ÷ 26.5).

How RMDs Impact Your Overall Retirement Strategy

RMDs increase taxable income in retirement, potentially moving you into a higher tax bracket or even affecting Medicare premiums. For many retirees, high withdrawals can trigger bigger bills than expected.

However, not everyone needs to liquidate large portions of retirement accounts early. At 2Pi Financial, we often stress that your investment risk should align with your overall financial picture, not just your age. If you still anticipate substantial earnings—or if you have a unique portfolio structure—the standard “glide path” of reducing equity as you age might not fit your goals.

Inherited Accounts and Beneficiaries

RMD rules can be more complex for inherited retirement plans. Non-spouse beneficiaries typically have to deplete an inherited IRA or 401(k) within ten years, though some exceptions exist for eligible individuals, such as minor children or beneficiaries with disabilities.

Beneficiary designation also affects RMD calculations. To explore these nuances, you might visit our detailed resource on understanding beneficiaries and payouts in retirement accounts. It offers insights on how distribution rules shift when a spouse or non-spouse inherits an account.

Why Roth IRAs Are Different

Roth IRAs, unlike their traditional counterparts, have no RMDs for the original owner. Contributions to a Roth IRA are made with after-tax dollars, so mandatory withdrawals don’t apply in the same way.

This difference often leads retirees to consider converting a portion of their traditional IRA or 401(k) to a Roth. If you want to see how taxes play out in each scenario, check out our discussion on Roth IRA vs. Traditional IRA: Tax Implications Explained.

Planning Tools That Simplify RMDs

Many platforms now provide an RMD calculator or automated reminders. If you’re seeking an advanced yet user-friendly approach, consider the innovative tools from Two Pi Financial. Our 2Pi Financial Planner demonstrates how different savings rates, risk profiles, and retirement dates can change your retirement picture.

After plugging in the details, you’ll see how recommended withdrawals (including RMDs) might shift with inflation or adjustments in portfolio allocations. This type of modeling can help you avoid unpleasant surprises when your RMD date arrives.

Simple Tips to Stay Compliant

Tip 1: Aggregate Multiple IRAs
Though you calculate an RMD for each IRA, you can withdraw the total from any single IRA or split it among multiple accounts. This flexibility helps if you prefer to leave certain investments intact.

Tip 2: Keep Track of Deadlines
Your first RMD occurs by April 1 of the year after you hit the RMD age. After that, each year’s withdrawal is due by December 31. If you miss it, you face a penalty of 25% of the untaken amount (reduced to 10% if you correct the error within two years).

Tip 3: Consider Charitable Strategies
Qualified Charitable Distributions (QCDs) let you direct up to USD 100,000 from your IRA to a charity. This move can satisfy an RMD while keeping that distribution out of your taxable income.

Tip 4: Check Employment Exceptions
If you’re still employed by the plan sponsor, you might delay your first RMD from that 401(k). However, this rule doesn’t apply to IRAs or 401(k) balances from previous employers.

Fitting RMDs Into Your Allocation Philosophy

Some retirees assume that as they age, they must always shift heavily to bonds or cash. At 2Pi Financial, we maintain that risk should hinge on your future earnings potential and wealth ratio—not just your birthday.

In certain cases, individuals can afford more stock market exposure even later in life. That choice can affect the level and frequency of RMDs you draw, especially if you expect your investments to keep growing over time.

Key Takeaway

RMDs require thoughtful attention. They’re non-negotiable once you reach the specified age, and missing them can be quite costly. Yet they also present strategic opportunities for tax planning, charitable giving, or portfolio rebalancing.

If you want to optimize your RMD strategy in light of your location, read our guide on state income tax rules for retirees in NY, NC, and FL. By tailoring your approach to your state’s tax structure, you’ll be better positioned to manage your retirement withdrawals effectively.

References

1. TIAA. (2023). “FAQs About Required Minimum Distributions.” Available at: https://www.tiaa.org/public/support/faqs/required-minimum-distributions
2. Internal Revenue Service. (2023). “Retirement Plan and IRA Required Minimum Distributions FAQs.” Available at: https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
3. SmartAsset. (2023). “How to Calculate Your RMD.” Available at: https://smartasset.com/retirement/how-to-calculate-rmd