The rules for required minimum distributions or RMDs change occasionally, but there have been many changes in the last few years. Knowing the rules for 2021 can save you income taxes and help you avoid any penalties.
RMDs are, as the name suggests, required and there is a penalty if you do not take the amount you are supposed to. This penalty is 50 percent of the amount that you should have taken but did not. You also have to pay income taxes on the amount distributed.
In 2020, RMDs were suspended for retirement plans like 401(k)s and IRAs, but this suspension did not continue into 2021 and is unlikely to be reenacted. It would take an act of Congress to do so and with the economy in recovery from the early stages of the COVID-19 pandemic, it is unlikely they will do so.
The beginning age for having to take RMDs was changed in 2019. If you turned 70.5 before 2019, the law required you to take your first RMD by April 1 of the year you turned 70.5. If you turned 70.5 after 2019, things are a little different. You have to take your first RMD by April 1 of the year you turn 72, giving you an extra year and a half to do so. People who turned 72 in 2020 were able to skip this first RMD.
RMDs from IRAs
Those who turned 72 in 2020 may be confused about whether they need to take their first RMD by the end of the calendar year 2021 or April 1, 2022. Remember that this is the first RMD they will take as there were no required distributions in 2020. But, they still turned 72, the 2021 RMD can be considered their second RMD as they were exempt from the first. So, if you turned 72 in 2020, it’s a good idea to take an RMD by December 31, 2021 to make sure you avoid penalties.
Generally, the first RMD doesn’t isn’t required until April first of the year you turn 72, but every year after that, you have to take it by December 31. So, if you skipped your first one in 2020, you should assume you have to take other RMDs by December 31.
Here’s an example. If you turn 72 in 2021, you can wait until April 2022 to take your first RMD, but remember that will have to take the next one by December of 2022. That’s two disbursements in nine months, which may drastically increase your taxable income and even push you into a higher tax bracket. When you’re retired, this can have many repercussions, like paying higher taxes on your Social Security payments or paying a higher cost for healthcare. In this case, taking the first disbursement in 2021 is a better option as it will prevent your 2022 income from being significantly higher.
Figuring Out an RMD
An RMD for 2021 is calculated by taking your balance as of December 31, 2020 and dividing it by your life expectancy. Life expectancy is determined by the IRS and published in a table that’s available in Publication 590-B, which is all about distributions from IRAs. This document can be found on the IRS website. There are multiple tables to look at, but most people use Table III.
The result of this calculation is your RMD. You can always take more than this amount if you’d like, but you have to take at least the amount that is determined to be your RMD. Anything extra that you take isn’t applied toward the RMD for the next year, either. You will still have to take the same recommended amount, using the balance of your IRS as of December 31 and dividing that number by your expectancy again.
Life expectancy tables were recalculated in late 2020 when the IRS proposed changing the regulations to adjust for the fact that life expectancies are getting longer. These new figures will be used for the first time at the end of 2021 when figuring out RMDs for 2022.
If You Have Multiple IRAs
If you have more than one IRA, you have to figure out the RMD for each one, but you do have some options. You can take a distribution from each individual IRA or you can add the RMDs together and take the whole amount from any of your IRAs. You can take it all from one or spread it out evenly among all of them if you wish. But the total must be the sum of the RMDs for all of your IRAs.
Note that this method is only possible with traditional IRAs. With other retirement accounts, like 401(k)s, you have to treat each account separately. That is, you have to figure out the RMD for each account and take that amount from that specific account. You cannot aggregate them.
You Don’t Have to Take a Lump Sum
Another thing to remember is that you don’t have to take a lump sum at the end of every year. You can spread out your disbursements evenly over the year or take out whatever you need as you need it. But the final amount must add up to your RMD.
Another option? You can make a qualified charitable contribution. A qualified charitable contribution doesn’t count toward our gross income so it’s beneficial for tax purposes, but it does count toward your RMD.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Any opinions are those of Thomas Fleishel and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation.
The example used is a hypothetical and is not a recommendation.
RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.