There is no shortage of acronyms in the world of personal finance. Between your HYAs, your NAVs, and your REITs, it can be hard to keep up with everything. But one of the most important acronyms, especially as you approach retirement, is RMD, or required minimum distribution.
An RMD is the amount you must withdraw from your tax-free retirement account when you reach age 72. Knowing how it works is an important part of retirement planning.
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1. They are required by most retirement accounts
If you have a tax-deferred retirement account, you may have to take RMDs starting at age 72. If you turned 70 before June 30, 2019, you may have been required to start taking RMDs at age 70 1/2. Retirement accounts that have this requirement include most 401(k) and 403(b) plans, as well as traditional, SEP and SIMPLE IRAs. You do not have to take RMDs from Roth IRA accounts.
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2. Different accounts have different RMDs
If you have multiple IRAs (other than Roth IRAs), you must calculate multiple RMDs (one for each account). However, you have the option of paying the total contribution amount of all your IRAs from a single IRA account as long as the total amount is met.
For example, if you are required to withdraw $1,000 from one IRA and $2,000 from another IRA, you may choose to withdraw only $3,000 from one IRA to meet your RMD requirement.
The rules for 403(b) accounts are the same as for IRAs, but for 401(k) accounts, it’s a little different. If you have multiple 401(k) accounts, each will come with its own RMD amount, and you must make withdrawals from each account.
3. Consolidating your accounts can work for you
Does the above give you a headache? In some cases, you may find it easier to consolidate your retirement accounts so you can more easily calculate your RMDs. If possible, try to do it before age 72 so you don’t scramble at the last minute or worse, incur late penalties for not taking your RMDs on time.
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4. They are (usually) kicked out from age 72 onwards
In most cases, RMDs begin at age 72, and you must take your first RMD by April 1 of the year after you turn 72. Remember that if you wait until you turn 72 to take the first year, you must take two distributions that year.
For example, if you turn 72 in July 2022, you can wait until April 1, 2023 to take your RMD for 2022. You must also take an RMD for 2023 by December 31, 2023.
However, if you are still employed by the company, the IRS does not require you to take RMDs from that company’s retirement plan, provided you do not own more than 5% of your company’s stock. This only applies to RMDs you have with that company, so you can start taking RMDs from other accounts after age 72.
5. They are based on your life expectancy
Each of your RMDs will be calculated based on your account balance and your life expectancy. If you have multiple RMDs, you must calculate each separately using the IRS life expectancy table. The tables differ depending on whether you have a sole beneficiary spouse and your spouse’s age.
6. There is a penalty if you are late
The penalty for missing an RMD is severe. If the RMD is not taken on time, or is less than the required amount, the IRS will charge you 50% of the amount not taken on time.
That means if you were supposed to take a $1,000 RMD and didn’t, you’d owe the IRS $1,000 and a $500 penalty.
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7. Roth rollovers can be beneficial
If you roll over your retirement savings, such as traditional IRAs and 401(k), into a Roth IRA (also known as a rollover), you’re no longer required to take RMDs. Instead, you can leave your money in your Roth account for as long as you like, and you can even choose to never withdraw it and leave it as an inheritance.
You also won’t have to pay any taxes on withdrawals from your Roth account as long as you’re over age 59 1/2 and have owned the account for at least five years.
However, be careful. when you roll over accounts to a Roth IRA, you pay tax on the money you roll over when you roll over. This can lead to a hefty tax bill. On the plus side, you won’t have to worry about RMDs.
8. QLACS can also help
A QLAC, or qualified longevity annuity contract, is designed to combat the problem of outgrowing your retirement savings. You use retirement account funds to purchase a QLAC, which provides you with a guaranteed income stream for the rest of your life.
You can wait until age 85 to start receiving income from an annuity. That’s also the age you’re required to start taking RMDs from your annuity.
9. You can donate RMDs
Feeling charitable? Good news. it’s actually possible to donate your RMDs as a qualified charitable distribution (QCD), and doing so is a great way to make a positive impact on some of the causes that matter to you. You can donate up to $100,000 as a QCD.
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The act of retiring requires a lot of planning and accounting, but there are some things you can do to make sure you’re not throwing money away.
Even if you haven’t yet reached retirement age, it’s worth finding an accountant to help you avoid taxes on RMDs. Knowing what to expect with RMDs saves you from a nasty surprise. Do the research now, your future self will thank you.
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This article 9 Facts You Should Know About RMDs originally appeared on FinanceBuzz.