Example of How RMD’s Work. Paying Taxes on Unneeded RMD’s? - Cravitz Financial & Insurance Solutions

Example of How RMD’s Work. Paying Taxes on Unneeded RMD’s?

In this video I show you an example of how required minimum distributions (RMD's) work. Many people have to take RMD's that don't actually need the income. Others need to take a larger RMD than they would want. Unfortunately, doing a great job of saving and accumulating large sums in pretax retirement accounts could lead to unwanted taxes in retirement. Not only do you have to pay income taxes on the IRA withdrawal, but it could also increase how much of your Social Security is subject to incomes taxes. Also it could increase how much you have to pay for Medicare. And if you are married, but your spouse passes away you lose a standard deduction. Also, you pay taxes based on the single tax table as opposed to married and filing jointly which is not as favorable from a tax standpoint.

Full Transcript:

How's it going everybody? It's Ryan here. Okay. So how do RMDs work and how much might you have to take out of your IRA over the course of your lifetime? That's what we'll look at here in this video. In a second, I'm going to share my screen here with you. But real quickly, I just want to make sure everybody's up to speed on a couple of things.

An RMD is a required minimum distribution, and you have to start taking out a required minimum distribution from certain retirement accounts, such as a 401k or an IRA, once you reach the age of 72. Now one exception in the year 2020 here, I'm recording this video in 2020, the Cares Act was passed earlier this year and as a result of that nobody has to take out an RMD, but that's just for this year. Going into 2021 and beyond RMDs are going to be a thing again. So let's make sure we understand how it works.

All right. So with no further ado, let me go ahead and share my screen.

All right. So what we're looking at here, this is just a purely hypothetical example. I've got a 65 year old with, coincidentally or not the exact same birthday as his spouse. So they're both 65, both born October 1st, 1955. And he's got exactly a million dollars in his IRA account and he earns exactly 6% on his money from now until he passes away, so as long as he owns the account. And that 6%, by the way is a completely arbitrary number, I could have plugged in whatever interest rate I would like there, perhaps that's a realistic number though for them to achieve in their retirement years. All depending on how they're invested and all that sort of thing. But we could plug in any figure there, we could go lower four or 5%, we could go higher seven or 8% or beyond. It's entirely up to you, but we're just using 6% in our example.

And let's see how this plays out, so we understand how this works. So the very first year, this is 2020, we go all the way over here. There's no required minimum distribution because right now he's 65 years old. But by the time he gets to be age 72, we can see down here, he's going to have to start taking out his first required minimum distribution, which is $58,736. Now, the way that that number is computed is that you take the year-end balance, which is this number right here, $1,503,630 from the year before. So he looks back to 2026 and there was a 1.5 approximately in that account, take this figure right here, divide that by the distribution divisor, which is 25.6. And you get this number right here, which is 58,736.

At 72, the very first year you have to take out an RMD, this number works out to be about 3.9% of that year end account balance for last year. Now over time, percentage wise, the amount that you'll have to take out from your account actually increases. So what you're seeing here also is that this distribution divisor goes down. Which means that there's going to be more money that you have to start taking out from your retirement accounts, all else being equal.

But the other factor that also comes into play here is that if he's earning 6% on this money, even though he's taking out the money that he needs to take out to satisfy his RMDs, his account is still growing, you can see it's still going up here. So he has to take out a higher percentage amount of a higher account balance, which means those RMDs are going to continue to increase over time. Now some of you are in a fortunate position where you don't even need to take your RMDs and you have enough other income sources available to you. And so what that means is that this is just money that you're going to have to pay taxes on each year. So it's something to be aware of that, in the beginning it starts small, again, relatively small, $58,000 approximately. Over time it continues to escalate. For instance, by the time you're 90 years old based on these projections, you've got to take out $138,000 just to satisfy the RMD. That's the minimum that you have to take out and pay taxes on it. Uncle Sam wants their tax money, that's really the key thing.

Now, one of the other exceptions here is that, although I did say you have to take out your first RMD at 72, technically that's not true. You can wait to take your very first RMD as long as you do it by the following year, by April 1st. So you could not do an RMD here, but this next year, when you're 73, you're now having to take out both RMDs. This one needs to be done by April 1st and the second one, the 62,150 needs to be done by December 31st of that following year. So add these numbers here together, I'm not going to do it on my calculator, but 58 plus 62, that's about a 120,000 plus this. So it's over $120,000 that you'd have to take out all in the same year, so you may not actually want to do that. You may want to spread it out over this two year period.

So hopefully all this made sense, and this is just the basic example, generic, we've got a 65 relevant million dollars, exactly a 6% rate of return. Now your situation could obviously vary, but conceptually, this is how it works. And it's important to understand how this works for a few different reasons. I mean, one, we just want to make sure we have a general understanding of how RMDs work. But it's also important to understand that this could potentially really be a problem because one of the things that you want to do in order to maximize the strength, or at least potentially maximize the strength every time you plan, is to seek to minimize the amount of total income tax that you're going to have to pay. Because as you take money out of your IRA to satisfy your RMD each year, and especially if you have to take out an increasing amount, that's going to mean even more income taxes that you're going to have to pay over time.

Not only that, but here's something that a lot of people don't think about, that could also increase the amount of the taxes that you have to pay for your social security. So understand social security in and of itself is not taxable, at least on a federal level. Now I'm not going to talk about state taxes at all, because that can vary from state to state, we got 50 different states so we can't go through all the state tax rules. But on a federal level, social security in and of itself is not taxable. It's just other certain income sources combined with social security that can make you have to pay taxes on your social security as well.

By the way, let's say your only other income source was social security and a Roth IRA. If you take out a qualified distribution from a Roth IRA, and then you also have social security, you won't have to pay any income taxes whatsoever. You can have a $50,000 withdrawal from a Roth IRA and $50,000, let's say from your social security, maybe combined husband and wife, you're living on a hundred thousand paying no taxes. But going back to this RMDs from IRAs can increase how much of your social security benefits are subject to taxation.

Now at the most you'll ever have to pay is taxes on 85% of your social security benefits. But if you can seek to reduce how much you have to pay in taxes on your social security that can really help to improve your overall tax situation. I'll do another video just on that at another time.

Also another thing is on Medicare, by increasing your overall income that can increase how much you're going to have to pay for your part B and part D premium, because that's all based upon your income as well. And another really important thing that a lot of people forget about here is that again, if we're looking at a married couple, right now, and let's say for instance this person 65, maybe this person passes away. God forbid they pass away early, they passed away at 75. Well, now that's 69,000 that they have to take through the form of an RMD. Now, if that person passes away the remaining spouse is now filing single, not joint, which means they only have one standard deduction, not two, and it also means they're in a whole different tax bracket table. And that tax bracket table is not as favorable as the one as if you were married. And so what that means is that they're going to have to pay even more in taxes on this same dollar, more than likely, obviously you got to crunch the numbers. But it's much more than likely going to be the case. So I'll make a note on that. I'm going to do another video on that as well, to really dive into the details on that.

But it's important to understand on how all this works. I'll keep it at that, just for this video here today. If you have questions, let me know. Until next time, I'll see you again soon.


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