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Required Minimum Distributions

‘Tis the season for Required Minimum Distributions or RMDs. These are the distributions that some investors must take from their 401(k), IRA or other retirement plan each year. If the money went in before paying any tax (pre-tax), the IRS requires distributions—and the payment of taxes on those distributions—once a person has reached age 721

And those distributions must be completed no later than December 31st of each year.

In 2020, because of a provision in one of the COVID relief bills, you didn’t need to take your RMD. Not so this year (2021). The regular rule has returned and, for many investors the RMD is big.

RMDs are calculated using a special formula dictated by the IRS. In general, the distribution is based on your life expectancy and account balance at the end of the prior tax year. For example, if you turned 72 in January and have an IRA that had an ending balance of $1 million at the end of last year, your RMD is $39,062.50.2

Right now we are calculating RMDs for all of our clients that have not yet taken their 2021 RMD. With no RMDs due in 2020 and higher balances due to a strong stock market, many investors will be taking RMDs that are much larger than those taken the last time around.

Do I really have to take my RMD?

The IRS is serious about investors taking their RMDs. The penalty for not taking your RMD is 50% of the amount that you should have taken. Using the above $1 million IRA as an example, if you fail to take your RMD, the IRS will apply a penalty tax of 50% of your RMD or $19,531.25—and that’s in addition to ordinary income tax on the full RMD and possibly interest penalties. So, it is wise to plan ahead and make sure you don’t miss the deadline and also take the right amount.

What can I do to minimize the tax on my RMD?

Once you’ve reached the age when you have to start taking RMDs, your options are limited. However, if you are charitably inclined, there is an option where you can give to a charity and fulfill your RMD. It is called a Qualified Charitable Distribution (QCD). Here’s how it works: If you are subject to RMDs, you can direct some or all of your RMD to a qualified charity(ies) up to $100,000 per year. In order for the distribution to count, it must be made directly from your IRA to a qualified charity.3    Sorry. Your kids might think they are qualified charities, but they don’t count.

That distribution is tax-free. Given that you never paid income tax at any point on the QCD, it can be an attractive option, especially for higher income taxpayers. You can even make a QCD to a charitable gift fund (see our blog: “Are donor-advised funds right for you? 4 key tax advantages” posted on 4/16/2021).

While there isn’t much you can do once RMDs begin, another option to consider is converting a portion of your pre-tax 401(k) or IRA to a Roth. Because Roths are not subject to RMDs, the account can grow for a longer period of time or even be used as an estate planning tool for high income heirs.

If you have questions about RMDs, qualified charitable distributions, donor-advised funds, or Roth conversions, give us a call, we’re here to help. You can schedule a quick call with me by clicking HERE.

Lyman H. Jackson Lyman@PlanWithFPS.com


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· The IRA tax bomb and why Roth conversions are more important than ever

· Are donor-advised funds right for you? 4 key tax advantages

· Roth conversion considerations

1 Or age 70½ if you attained age 70½ before 2020.

2 Special rules apply if you are married to someone who is more than 10 years younger than you or if your spouse is not the sole beneficiary of your IRA.

3 To make a qualified charitable distribution, the charity must be a 501(c)(3) organization.

Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.

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