New rules on required minimum distributions
Congress late last year revised the rules on required minimum distributions (RMDs) that retirees must start taking in their 70s from tax-deferred retirement accounts. Here’s what you need to know.
In 2023, the starting age for taking RMDs from traditional individual retirement accounts, 401(k) s and other tax-deferred plans increases to 73, up from 72. In 2033, the starting age will increase to 75.
The change means that individuals who turn 72 this year will get a one-year delay in RMDs, says Tim Steffen, director of advanced planning for Baird. (Technically, you can wait until April 1, 2025, to take your first RMD, but that means you’ll need to take two RMDs in 2025.) The legislation isn’t retroactive, so if you turned 72 in 2022, you’re still required to take your first RMD no later than April 1, 2023.
Retirees who don’t need money from their tax-deferred accounts may welcome the delay in RMDs, especially if they need more time for their portfolios to recover from last year’s bear market.
The delay could also give retirees more time to convert some of the money in their traditional IRAs to a Roth IRA. Roth IRAs have no RMDs, and because they’re funded with aftertax dollars, withdrawals are tax-free.
But once RMDs kick in, you can’t convert to a Roth until you’ve taken your required distribution, which could result in a hefty tax bill.
Still, there are downsides to postponing RMDs because you (or your heirs) are eventually going to have to pay taxes on funds in tax-deferred accounts.
RMDs are calculated based on the amount of money in all of your tax-deferred accounts at the end of the year and your life expectancy as determined by the IRS’s Uniform Lifetime Table. When you’re eventually required to withdraw money, the amount of the RMD could be large enough to push you into a higher tax bracket. For that reason, many financial planners recommend taking modest distributions from your tax-deferred plans long before you’re required to make withdrawals.
Perhaps in a nod to increased confusion about the timing of RMDs, the new rules significantly reduce the penalties for missing an RMD or taking out less than you’re required to withdraw. Starting in 2023, the penalty drops to 25% of the amount you should have withdrawn, down from 50%. The penalty drops to 10% if you take the necessary RMD by the end of the year following the year the RMD was due.