Required Minimum Distributions: Planning for RMDs in 2023

Many of our clients have benefited over the years from the opportunity to contribute to a 401(k) or 403(b) plan sponsored by their employer. As they near retirement, we regularly get questions about required minimum distributions, which are often referred to simply by their acronym: RMDs. This is especially true in 2023, as a new law passed at the end of 2022 changed the playing field. Let’s go over what RMDs are, how the rules have changed, and what all of this means for your finances overall.

What are RMDs?

Essentially, the IRS requires those in or near retirement to take money out of their retirement account each year. In their words: You cannot keep funds in your retirement account indefinitely. So, when you reach a certain age, you must begin making withdrawals from any non-Roth retirement accounts you have, including 401(k)s, 403(b)s, IRAs, SEP IRAs, and so on.

We usually work together with clients to incorporate these required payments into a broader retirement income strategy. And while the distributions are mandatory, they don’t necessarily have to be cash payments used for income.

You don’t generally need to calculate your own RMDs, as your retirement plan sponsor or plan administrator often handles this. However, it can be helpful to understand the methodology. Essentially, the IRS provides you a number, known as the distribution period. You then take your retirement account balance from December 31 and divide it by the distribution period. That’s the amount you’re required to take out in the following year.

How did SECURE Act 2.0 change RMDs?

In late 2022, Congress passed SECURE Act 2.0, which revised a number of provisions tied to how Americans save and plan for retirement. The law made notable changes to RMDs.

Starting January 1, 2023, retirees do not have to take RMDs until they turn 73 (previously, it was 72). That means if you turn 72 this year, and you haven’t taken any RMDs yet, you can likely defer those payments until your next birthday. This is significant because it gives retirees another year to let their savings grow and delay tax liability.

In 2033, the age increases again to 75, meaning anyone currently in their 60s may want to revise their retirement plan accordingly.

SECURE 2.0 lessened the penalties for missed RMDs, too. Starting this year, missed distributions will be penalized at 25% of the missed distribution, or 10% if the issue is corrected within a reasonable time.

The SECURE 2.0 Act also eliminated RMDs for Roth 401(k), Roth 403(b), or other Roth options through employer-sponsored accounts. This change will go into effect starting in 2024.

Planning for RMDs

RMDs tend to be a foundational part of retirement income planning, precisely because they’re retired. But not all retirees use these payments as traditional income. When we talk to clients about retirement income, we’re looking at multiple factors.

For instance, you can take RMDs at whatever cadence you like—you might set up quarterly or monthly payments to help with cash flow, or take a lump sum payment at the end of the year to use for a large purchase or vacation. We often recommend clients take monthly distributions as this can resemble a more traditional paycheck and help with budgeting.

If you don’t need the RMDs as income, you still have to take the disbursement, but you don’t have to take it in cash. We often talk to clients about using their RMDs as a tool for charitable giving. Qualified charitable distributions (QCDs) allow you to directly donate to a qualified charity or organization from your retirement account. If the funds go directly from your retirement account to the organization, these donations generally satisfy the RMD requirements.

When should you start taking RMDs?

In an ideal world, we’d suggest clients wait as long as possible to begin taking RMDs to give their money a chance to grow tax-free for as long as possible. But it’s not always that simple.

For starters, the greater your account balance, the higher your RMDs will be. And, depending on your circumstances and goals (including your plans to pass wealth along to your family), you may benefit from starting these withdrawals sooner.

One concern we hear quite frequently? “I don’t want to outlive my money.” When we get this question, we try to remind clients that you can do more with your retirement account than draw it down as income. For instance, you could use a lump sum from your 401(k) or IRA to purchase an annuity of some kind. You can also convert funds from a traditional to a Roth retirement account leading up to retirement, since paying taxes on those funds now reduces your taxable balance later.

If you have questions about how RMDs affect your retirement income or your overall retirement plan, feel free to reach out to our team. We’d be more than happy to discuss the different options you may have.