Planning Opportunities to Consider Before Year-End – A Series Part 1 – Required Minimum Distributions

The end of the year provides a number of planning opportunities and issues for us to discuss with our clients. Year-end topics can include tax planning, rebalancing investment and retirement accounts, Roth IRA conversions, charitable giving, reviewing cash flow and savings rates, as well as insurance and estate planning. As we have in previous years, we will address a number of planning issues over the next few weeks that you may want to consider prior to year-end to ensure that you’re on track, beginning this week with Required Minimum Distributions (RMDs).

A Required Minimum Distribution, or RMD, is an IRS-mandated amount of money that you must withdraw from traditional IRAs or employer-sponsored retirement accounts each year. It’s important to understand when you need to take an RMD, how to avoid potential costly penalties for late distributions, and to maximize your withdrawal strategy.

The IRS updated their Retirement Plan and IRA Required Minimum Distributions FAQs to reflect the change in the qualifying age for RMDs brought by Congress passing the Secure Act 2.0. For retirement account owners who recently reached the qualifying age for a required minimum distribution or inherited an IRA in the last year, withdrawing your RMD can be a new process and potentially costly if not incorporated into your plan properly.

The IRS requires that you start taking RMDs from your tax-deferred retirement accounts at age 73. Technically, your first RMD must be taken by April 1st of the year after you turn 73. This would allow those clients turning 73 in 2024 the ability to defer this first withdrawal until 2025. This may seem like a good idea to avoid incurring taxes this year; however, you would still be required to take your age 74 RMD by December 31st of that calendar year. This results in taking two distributions in the same tax year which may push you into a higher tax bracket, creating a higher total tax bill and impacting the taxes you pay on Social Security and Medicare. There’s no way to avoid paying income taxes so we help our clients pay their taxes at the lowest possible rate when we can. Working with your ACM advisor to incorporate your RMDs as part of your annual cash flow plan is essential to optimizing your income in retirement.

RMDs must be taken out of tax-deferred retirement accounts, including:

• Individual Retirement Accounts (Traditional, Rollover, SIMPLE & SEPs)
• Most Qualified Employer Retirement Plans (401k’s and 403b’s)

RMDs from multiple IRA accounts can usually be aggregated, meaning your RMD will be calculated using the previous year-end account value of all of your retirement accounts combined (if you have multiple). You can designate which accounts to take your distributions from, taking more or less from one or others. RMDs from qualified employer retirement plans usually must be calculated and taken separately, with no aggregation allowed. However, 403(b) plans are an exception, and RMDs from multiple 403(b)s can be aggregated. If you are still working, you may also be allowed to delay an RMD from a 401(k) or 403(b) from your employer sponsored plan until after you retire. This rule does not apply to people who own more than 5% of the business for which they are working and you may run into the same issues of deferring distributions into future tax years, pushing you into a higher tax bracket and ultimately paying more in income taxes. Again, consulting with your ACM advisor to optimize distributions as part of your cash flow plan is essential.

The IRS taxes RMDs as ordinary income, meaning withdrawals will count toward your total taxable income for the year. Distributions will be taxed at your applicable federal income tax rate and may also be subject to state and local taxes. Some states that normally tax earned income may have preferential income tax treatment on retirement account distributions or don’t tax distributions from retirement income at all. It is important to know how your state treats retirement income as part of your overall plan. If you made after-tax contributions to your IRA, or 401(k) and did not roll them over to a Roth IRA, you have the ability reduce your taxable income proportionately by your basis of your contributions each year. We suggest you work in tandem with your ACM advisor and Accountant in these situations to avoid paying “double taxes” on after tax retirement plan contributions.

Don’t miss taking your RMD for the 2024 tax year, regardless of your account type as the IRS penalty is pretty severe—25% of the amount not taken on time. We all want to be efficient with planning our distributions, but giving away 25% to the IRA in addition to your tax obligation on your RMD is something we strongly advise avoiding. Secure Act 2.0 dropped this penalty to 25% from 50% starting in 2023, with the possibility of reducing it further to 10% if you take your missed RMD during the “correction window.”

There are no RMDs for Roth IRAs, unless they are inherited. We’ll address Roth conversions in a future commentary, but it may prove worthwhile to combine distributions from a Roth IRA with your RMDs to cover a spending need, rather than taking more than is required from your traditional retirement accounts if it will push you into a higher federal, state or IRRMA tax bracket.

Inherited IRAs are whole different animal thanks to the SECURE ACT 1.0 passed at the end of 2019. If you inherited IRA before 2020, you will continue to follow the old rules that allow the beneficiary that inherited the IRA to ‘stretch out’ RMDs over their life expectancy. For any IRAs inherited by beneficiaries in 2020 or later who are not eligible designated beneficiaries (spouses/minor children/disabled/not more than 10 years younger than account owners), the “stretch” was eliminated and replaced by the “10-year rule”. The 10-year rule means that IRAs inherited by adult children from their parents have to be completely distributed by Dec 31 of the 10th year after the year in which the account holder died. And now, in its new Final Regulations issued on July 18, 2024, the IRS has confirmed the requirement for Non-Eligible Designated Beneficiaries to take RMDs annually (although for beneficiaries who would have been required to take RMDs in 2021–2024 but didn’t, the IRS has confirmed that there will be no penalty and no requirement to make up the missed distribution, meaning the new regulation effectively starts with RMDs required to be taken in 2025). This provides a planning opportunity with your advisor on whether it makes sense to defer or accelerate distributions from an inherited IRA depending on, you guessed it, your applicable income tax rates.

As of the date we’re publishing this commentary, we are still waiting on specific cut-off dates from Fidelity and Schwab for processing 2024 RMDs. As with all things in life at year-end, the custodians get busy too and any requests to process RMDs sent to the custodians after certain cut-off the dates listed below will be processed on a Best-Efforts Basis and are not guaranteed to be completed by 12/31/24.

As always, if you have any questions, then please reach out to your ACM Wealth Advisors. If you haven’t already, as part of a comprehensive review, speak with your ACM Advisor about your potential RMD obligation to make sure you are avoiding any penalties and not incurring unnecessary income taxes, both this year and in the future, by optimizing your withdrawal strategy.

Advisors Capital Management, LLC is an investment advisor registered with the United States Securities and Exchange Commission. Registration does not imply any degree of skill or training. All investing carries risk, including the potential for the loss of principal and past performance is no guarantee of future results. This content is for informational purposes only, can change at any time without notice, and is not investment advice or a recommendation to trade any security. Indices are not available for direct investment. We only provide services in jurisdictions where we are registered. Our disclosure brochure (ADV Part 2A) and customer relationship summary (ADV Part 3) are available at https://adviserinfo.sec.gov and upon request.