Taxation is primarily about the rules. And no matter how old you are, you must follow some rules. Most people have an Individual Retirement Account (IRA) or 401(k) or another similar retirement account.
The accounts function because the government never taxed the income or the earnings on the funds that individuals put in; often while receiving a tax deduction. Now the IRS is worried that people will never take the money out. Without significant withdrawals, the IRS is concerned they will not receive the share of taxes they are owed. Therefore, they issued many new rules on how and when one must take money out of retirement accounts.
These rules are called Required Minimum Distributions (RMDs). The money you take out, other than any portion attributable to after-tax contributions, is subject to income tax. These rules direct that a taxpayer must distribute funds from their retirement accounts as follows:
RMDs must be taken annually starting at age 73 (for those born in 1951 or later) from traditional IRAs, 401(k)s, and other tax-deferred retirement accounts. The age was recently increased from 72 to 73 by new rules enacted in 2022.
The RMD amount is calculated by dividing the prior year-end account balance by a life expectancy factor published by the IRS based on age.
The first RMD must be taken by April 1 of the year after turning 73. Subsequent RMDs must be taken by December 31 each year.
RMDs are calculated separately for each retirement account you own. However, you can take the total amount from one account or a combination of accounts.
Failure to take the full RMD results in a penalty tax, recently reduced from 50% to 25% of the shortfall by the 2022 Act. The penalty can be further reduced to 10% if corrected timely.
RMDs do not apply to Roth IRAs during the original owner's lifetime. However, they do apply to inherited Roth IRAs.
For inherited IRAs, non-spouse beneficiaries must generally withdraw the entire balance within 10 years, with some exceptions.
Starting in 2024, if you are 70 ½ or older and have an IRA, you can donate more money to charity from your IRA without it being taxed. The limit went up from $100,000 to $105,000 per year, and this donation can even count towards your required minimum distribution (RMD). There's also a new option to donate up to $53,000 to create a special type of charitable account that gives you income for life.
So, in summary, once you reach age 73, you must start taking the required minimum distributions annually from most retirement accounts based on IRS life expectancy tables to avoid steep penalties. If you have any questions, concerns, or would like assistance planning for retirement, please contact the trusted accountants at Chugh, LLP.
