Retirees who are at least 73 years old and have a 401k or Traditional IRA must take Required Minimum Distributions for 2023.For those who already had to take these RMDs in the past, the 2023 distribution must be taken by Dec. 31.
In most years, the IRS give you an automatic extension until April 1 of the next year to take your very first RMD. Because of a change in the law that shifted the age of your first RMD from 72 to 73 in 2023, virtually everyone subject to RMDs in 2023 was already subject to them in 2022. As a result, that particular extension has very little meaning this year.
If you don't take your RMD in time, you will be forced to pay a 25% penalty on the money you were supposed to withdraw but didn't.Note that if you correct that missed RMD within two years, the penalty can get reduced to 10%. Even reduced, though, that's a penalty on top of the taxes you'll end up paying on the distribution. So, if you face an RMD for 2023, you should take it in 2023.
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Is there a way to avoid a RMD?
In 2023, all qualified retirement accounts except Roth IRAs are subject to RMDs. If you're still working for an employer and not considered a 5% owner of that company, you can avoid taking an RMD on a 401k sponsored by that employer.
That still-employed deferral does come with a catch, however. Once you retire, you will have to start RMDs on that account. Since you hadn't been taking them before, your account balance will be bigger than it would have been if you had been taking those distributions.
Since your RMD amount is based on your age and account balance-- the higher both numbers are, the bigger your RMD -- that early avoidance means your later RMDs will be that much larger. That could create or exacerbate a "tax bomb" in retirement by boosting your taxable income from those later RMDs.
If you're charitably minded, you can use a Qualified Charitable Distribution to reduce the amount you would otherwise need to take as an RMD. By making a contribution of up to $100,000 directly from your IRA to a qualified charity, you reduce your RMD amount, dollar for dollar. If you're married and both spouses have IRAs subject to RMDs, the amount for the household can double, up to $200,000, $100,000 for each spouse.
By making a qualified charitable distribution, not only do you reduce your RMD, but the money you send to the charity never counts as taxable income to you.That helps reduce that potential tax bomb while helping out the charity of your choice.
A key benefit of Roth IRAs
Another approach people use to keep their RMDs in check is to convert their retirement account balances to Roth IRAs. Roth IRAs are not subject to RMDs in the original account owner's lifetime. As a result, once your retirement money is in one, it can stay there the rest of your life, growing completely tax free until you need to spend it or pass it on to your heirs.
By making partial Roth IRA rollovers over time, you can reduce the money in your other retirement accounts, thus reducing their future RMD amounts and the tax burdens they create. Roth IRA rollovers are taxable, but people with large retirement account balances often find that the conversions still make sense from a "pay me now or pay me more later" perspective.
Note that if you are already required to take RMDs, you cannot roll the RMD amount into your Roth IRA.You can, however, apply some or all of the RMD amount toward the taxes you'll have to pay on any additional money you do convert to your Roth IRA. That can be helpful if you find that your RMD is larger than you need to withdraw to cover your costs.
Get started now
Whether you'll be directly taking your RMD, using a qualified charitable contribution to reduce the amount you need to take, or planning a Roth IRA conversion to reduce future RMDs, time is running out.
You must complete the actions by December 31 to have them count as timely for 2023. With the clock rapidly ticking down, make today the day you get your plan in place to meet your obligations on time.
