Tax-deferred retirement accounts like IRAs and 401(k)s have allowed your savings to grow without any immediate tax burden. However, once you reach a certain age, the IRS requires you to begin making withdrawals from these accounts – whether you need the money or not. These are known as required minimum distributions, or RMDs.

David Shapiro joins Better Money Boston with WCVB Channel 5 to discuss the important RMD facts you need to know, including when to start taking RMDs, how they’re calculated, and how they can impact your taxable income.

Knowing When to Start

The SECURE Act 2.0, passed by Congress in late 2022, established several new provisions to retirement planning rules, including adjusting the age at which retirees must begin taking RMDs. The age increased from 71 ½ to 72 with the passage of the original SECURE Act. As of today, with the SECURE Act 2.0, you are required to take your first RMD by April 1 of the year after you turn age 73. There’s even some speculation that lawmakers could raise the RMD age to 75 as life expectancies continue to rise.

Calculating Your RMD

A financial advisor can calculate exact numbers for you, but your specific RMD is essentially the value of all your retirement accounts at the end of the previous year, multiplied by a percentage based on your age. While you are only required to withdraw the minimum amount, you are free to take more if needed. However, keep in mind that any additional distributions above your RMD will still be subject to taxes.

Avoiding Hefty Penalties

It’s important to calculate and plan accordingly for taking RMDs. If for some reason you choose not to take an RMD or withdraw less than required, you will be penalized by the IRS. This can be a substantial penalty, too – as high as 25% on every dollar not withdrawn properly. To avoid this, make sure to stay on top of the withdrawal schedule each year with the guidance of your financial advisor.

Reducing Your Tax Burden

RMDs are taxed as ordinary income, and withdrawals count toward your total taxable income for that year. Depending on your total earnings, this additional income could push you into a higher tax bracket. It could also have a wide-reaching impact on Medicare premiums, Social Security taxes, marginal tax rates, and capital gains taxes. If you have the flexibility, there are ways to minimize your overall tax obligation, such as shifting the timing of your withdrawals.

Understanding and planning for RMDs is a crucial part of retirement planning. Consulting a financial advisor can help you navigate any future rule changes and create a withdrawal strategy that reduces taxes and supports your overall financial goals.