The nice thing about saving for retirement in a traditional IRA or 401(k) is getting to enjoy a tax break on the money you contribute. But there's a downside.
At some point, the IRS is going to force you to start withdrawing from your retirement plan whether you want to or not. Those mandatory withdrawals are known as RMDs, or required minimum distributions, and failing to take them when you're supposed to could result in costly penalties.
Meanwhile, if you're turning 73 this year, it means you need to start thinking about your first RMD. That means not only figuring out when to withdraw the money from your account, but also how to plan from a tax perspective.
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The new RMD rules
It used to be that your first RMD was due the April after you turned 70 1/2. That age was later pushed to 72 and then moved back again to 73. If you were born in 1960 or later, your first RMD actually does not have to be taken until age 75.
But if you were born between 1951 and 1959, your first RMD is due at 73. So if you're turning 73 this year, you'll need to start planning for that RMD.
But that doesn't necessarily mean you'll need to take your initial RMD in 2024. Your first RMD is actually due by April 1 of the year after you turn 73 -- so in this case, 2025. But if you're turning 73 this year, you might want to take your initial RMD in 2024 to minimize the tax hit.
Withdrawals from a traditional retirement plan count as taxable income. If you take your first RMD this year, you'll pay taxes on it this year. If you wait until April 1 of next year to take your first RMD, you'll pay taxes on that withdrawal next year. But you'll then have to take your next RMD by Dec. 31, 2025. So all told, if you push off your initial RMD to 2025, you'll have to take two RMDs in 2025, which could result in a less-than-pleasant tax hit.
Don't neglect your RMDs
You might be inclined to blow off your RMDs. But you should know that you'll be penalized 25% for every dollar you don't take in RMD form. So if you're on the hook for a $5,000 RMD you fail to take, you lose $1,250 off the bat.
Now that may sound harsh, but actually, the penalty for not taking RMDs was recently reduced from 50% to 25%. Either way, it's not a penalty worth taking when you can plan for your RMD ahead of time and get that money out of your account.
One final thing: While RMDs do effectively force you to spend down your IRA or 401(k) in retirement, you don't actually have to spend your RMD. So if you don't need the money, don't spend it. Invest it in a taxable brokerage account or use it to open a CD if rates are favorable.
It's in your best interest to take your RMDs when you're supposed to. But it's really important to plan for your initial RMD so it doesn't end up constituting a major tax headache.
