Understand Required Minimum Distributions (RMDs) – 5 Questions - Cravitz Financial & Insurance Solutions

Understand Required Minimum Distributions (RMDs) – 5 Questions

Required Minimum Distributions (RMDs) can be a confusing topic. What is an RMD and when do you have to take it? How much do you have to take? Can you aggregate your accounts? How are RMDs taxed. What are the penalties if you don't take an RMD? In this video I answer these questions.

Full Transcript:

What's going on, everybody? It's Ryan here. Okay, so today I want to talk to you a little bit about required minimum distributions, or RMDs for short. Now, there's no doubt this could be a little bit of a confusing topic and if you haven't had to take out an RMD before you probably don't even know what questions that you should even be asking. So what I thought I would do is just put together this short video and I'll answer some of the more commonly asked questions that I receive about RMDs. I've got five of them here. So, with no further ado, let's just go ahead and get started. First question was probably the most obvious, but we've got to start here. And that is what is an RMD. So an RMD is a required minimum amount that you have to start taking out of certain retirement accounts such as an IRA, a simple IRA, SEP IRA, 401K, 403B, 457.

It even includes Roth 401Ks, which is sometimes overlooked because if you take out a qualified distribution from a Roth 401K, you don't have to pay any income taxes, but you still have to take out the RMD. Now, Roth IRAs are different. With Roth IRAs you never have to take out an RMD. Now, having said that, if you have an inherited IRA or inherited Roth IRA, those rules are different altogether. In fact, I could do a whole other video just on an inherited IRAs or inherited Roth IRA. So keep in mind, those have different rules altogether. Okay, so I'm recording this video right now in October of 2020, and a couple things have changed with IRAs, but they're pretty big just over the course of the last year. So, at the end of last year, I think it was December 2019, the Secure Act was passed and as a part of the Secure Act, it changed what I call the so-called magical age of when you have to start taking out your first RMD.

So it used to be you had to take out your first RMD when you turn the age of 70 and a half. Now, it's age 72. And to make things perhaps a little bit more confusing, although it is a nice benefit for a lot of people that don't want to have to take out an RMD, earlier this year, the Cares Act got passed and as a part of the Cares Act that made it so that nobody in the year 2020 has to take out an RMD. But, typically, if you did need to take out an RMD and let's say you're 72, well, this is how it works. In the year that you turned 72, that's, again, the first year that you have to take out your first RMD, you can take it out that year, that calendar year, or you are allowed to, just for the first year, you're allowed to wait until the following year. As long as you take it out by April 1st of the following year, you can do that.

But if you do that, do keep in mind that still the next year you have to take out an RMD for that year as well. So if you delay the first one up until April 1st of the following year, you'll end up having to take out two RMDs in the same year, which you may or may not want to do. That just depends on your overall financial and your tax situation. Because if you do take out two RMDs in the same year, perhaps you'll end up paying more in total income taxes on that money than if you spread it out over a two year period. So you definitely want to keep that in mind. All right, second question. How do you calculate the RMD? So let me try to keep this as simple as possible. Basically, the way that it works is that in a year when you have to take out your RMD, you're going to look at what the account balance is of the account that you have to take out the RMD from on December 31st of the prior year at the end of the day.

So at the end of the year, what was that account balance? So take that number, and let's just keep it easy, let's say you had $100,000 in an IRA, so you take that number, $100,000, and then you're going to divide that by a number that shows in a chart that's on the IRS website. And that number changes from year to year. So when you're 72, the number right now, I think it's 25.6. I actually have it right here in front of me, because right now I'm forgetting. Yes, 25.6 is what it is the very first year. Basically, the way that it works is you would take $100,000 divided by 25.6 and you'll end up having to take out, not quite but almost, 4% of the account balance, of the money that was in the account. So almost $4,000 in this case. Now, having said this, that's I would say for most people. So if you're single or if you're married and your spouse is not more than 10 years younger than you.

Now, there is a second chart that applies if your spouse is more than 10 years younger than you, for instance. So I'll include these charts in a link down here below this video. All right, now, understand this too about RMDs, is that percentage wise the amount that you have to start taking out of your accounts goes up over time. So, as an example, by the time you're 80, you have to take out over 5% of the money that's in your account. By the time you're 90, it's over 8%. It's almost 9% that you have to take out the very first year. So it's quite a bit, especially over time. Third question, can you aggregate RMDs? Okay, so first let me answer, what do I mean by aggregate? So aggregate means this, best to give an example. Let's say you have two IRAs. You have ABC IRA and you have XYZ IRA, ABC IRA, you have to take out $5,000 in the form of an RMD, let's say. XYZ IRA, you have to take out $3,000, let's just say. So total between the two is $8,000.

Now, with IRA accounts, you can aggregate those together, meaning the total RA amount is $8,000 from the IRAs. You could take out the $8,000 from either the ABC IRA or the XYZ IRA. That is perfectly fine as long as you take out the total amount that needs to be taken out. You can also do the same thing with 403B accounts. So if you have multiple 403B accounts, you can aggregate those and take out the total amount of the RMDs, whatever they do total just from one 403B, if you so would like to do that. So IRAs and 403Bs, you can aggregate those. You cannot aggregate a 401K. So, for instance, you've got a 401K number one, then 401K number two. Well, you've got to take out an RMD from number one and from number two separately. You can't combine those. Can't aggregate those. So cannot aggregate a 401K, a 457. And that's the only other thing that I can think of off the top of my head. So that's how aggregation works.

One of the benefits actually when you get into retirement to definitely minimize headaches and such is if you can consolidate some of those accounts. You get through retirement and you're taking out RMDs from multiple different 401Ks and such, it can definitely be administratively a little bit of a headache, I would say. So just something to keep in mind. Okay, question four. How are RMDs taxed? All right, so let's say we're talking about an IRA or a 401K that was just funded with pre-tax dollars. When you go to take out your RMD, you're going to have to pay taxes on that money at ordinary income tax rates. And not only that, but it could also affect the taxation on your social security as well as your Medicare. So it is important to be aware of how that works as well. All right, question five. What if you don't take your RMD? Now, don't make this mistake. This is a huge penalty. The penalty is 50% on the amount that you should have taken out, but that you did not take out.

So let's say your RMD is $40,000. If you don't take that out, your penalty is 50% of the $40,000, which is $20,000. Plus, you'll still have to take out the RMD and pay the taxes. So it's a big penalty. Now, if you forgot, whatever the case might be, you definitely want to make sure that you notify the IRS right away. I do know of cases where people have notified the IRS quickly and they've had that forgiven. Now, I can't obviously make you any promises, but certainly if you make the mistake, don't take out the RMD. Make sure you notify the IRS as soon as possible. All right, with that, we're through the five questions. If you have questions on any of this or anything else related perhaps let me know. Until next time, take care. Talk soon.


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