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

Year-End Financial Planning Overview: Why RMDs Matter

The end of the year provides a number of planning opportunities including 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. We will address a number of planning issues over the next few weeks that our clients need to consider prior to year-end to ensure they stay on track, beginning this week with Required Minimum Distributions (RMDs).

Understanding 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 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 in 2022.  For clients 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.

When RMDs Begin and Why Timing Matters

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 turning 73 in 2025 the ability to defer this first withdrawal until 2026.  This may seem like a good idea, however, you would still be required to take your age 74 RMD by December 31^st of 2026.  This results in taking two RMDs in the same tax year, which may push you into a higher tax bracket and create a higher total tax bill and impact the taxes you pay on Social Security and Medicare.

There’s no way to avoid paying income taxes so we look to help our clients pay their taxes at the lowest possible rate where 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.

Accounts Subject to RMDs and How Withdrawals Work

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

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

How RMDs Are Taxed and Special Considerations

The IRS taxes RMDs as ordinary income, meaning withdrawals will count toward your total taxable income for the year.  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, then they should not be subject to income tax upon withdrawal.  This is often overlooked, particularly if you did not keep tabs on pre-tax/deductible vs. after-tax/non-deductible contributions, and we suggest you work in tandem with your ACM advisor and Accountant in these situations to avoid paying “double taxes” on any after- tax retirement plan contributions.

Make sure to withdraw your RMD for the 2025 tax year, regardless of your account type, as the IRS penalty is pretty severe—25% of the amount not taken on time.  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.”

Roth IRAs and Inherited IRA Rules

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 your spending needs, rather than taking more than is required from your traditional retirement accounts if it will push you into a higher federal, state or Medicare surcharge (IRMAA) bracket.

If you inherited an IRA before 2020, then you will continue to follow the rules that allow the beneficiary that inherited the IRA to “stretch” RMDs over their life expectancy. For any IRAs inherited by beneficiaries in 2020 or later who are Non-Eligible Designated Beneficiaries (i.e., adult children), then 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 10^th year after the year in which the account holder died.  If the original, now deceased IRA owner had already begun taking their own RMDs, then the adult children inheriting an IRA from a parent must also take RMDs during years 1 – 9 based on the own life expectancy.

There are some exceptions to the above, such as a surviving spouse, minor children and the disabled.  Absent these exceptions, however, the years 1- 9 minimum distributions will create more taxable income in each of those years.  The years 1-9 RMDs may also not make a dent in the total amount that needs to be distributed by the end of year 10, which could result in a significant amount of taxable income in year 10 and result higher federal and state income taxes along with losing other deductions. It’s highly recommended that you consult with your ACM Wealth Advisor and/or your tax preparer to plan for this if it applies to you.

Important Custodian Deadlines and QCD Opportunities

Requests to process RMDs sent to the custodians like Fidelity and Schwab after specific dates will be processed on a Best-Efforts Basis and are not guaranteed to be completed by 12/31/25.  As of this commentary, we do no have the dates yet from Fidelity and Schwab to share, but they have been between December 1 – December 11 in years past.

Lastly, you can make charitable contributions directly from your IRA to a qualified charity in order to reduce/offset your RMD if you are over 70.5 years old, which are known as Qualified Charitable Distributions or QCDs.  If you make QCDs as part of your RMD planning for the year, then keep in mind the above processing dates and the fact that any QCD checks that you may have written need to be cashed by the receiving charity by December 31.

Final Takeaway: Work With an Advisor to Avoid Mistakes

If you haven’t already, as part of your 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.   You can also read our recent commentary here about Planning for Required Minimum Distributions

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