About Required Minimum Distributions

By Zeke Anders on October 20, 2023

Once you reach age 73, you are required to take distributions from your IRA or 401(k). In 2033 the age will jump to 75. Prior to 2020 the start date was age 70 ½ , then 72 from 2020 to 2022. Required Minimum Distributions, RMDs, are often unpopular, mainly because they generate taxes. IRAs and 401(k)s allow your assets to grow tax-deferred, and eventually the IRS wants their piece of the account. Despite this unpleasant association, the way RMDs work may help change the way we think about spending and giving in retirement. This piece will cover how RMDs are calculated, how RMDs impact your account balance over time, and some strategies for mitigating the taxes from RMDs.

RMDs are calculated by dividing your account balance at the end of the previous year by a factor from the IRS Uniform Lifetime Table. The factor is based on life expectancy and represents the percentage of the account that must be distributed each year. As time goes on the percentage of the account you have to distribute increases. It doesn’t all have to be spent, of course, but you must take the funds out of the IRA or 401(k) and pay taxes on the distribution.

^{Source: https://www.irahelp.com/printable/uniform-lifetime-table-0 as of October 19th, 2023}

It is interesting to look at how the performance of your investments will effect the required distribution amount over time. For example, we’ll start with an IRA of $1,000,000 and assume constant growth at 4%, 6%, 8%, or 10%. RMDs are the only distributions from the account.

^{Source: https://www.irahelp.com/printable/uniform-lifetime-table-0 and author’s own calculations as of October 19th, 2023}

_{Source: https://www.irahelp.com/printable/uniform-lifetime-table-0 and author’s own calculations as of October 19th, 2023}

This chart shows the remaining balance each year, not adjusted for inflation. At lower growth rates it steadily, slowly declines. At higher growth rates the balance increases for a while, before turning down. You can see that at 8% growth the account balance is roughly flat at the end of year 30. Even at 6% growth, 60% of the account remains. Because the required distribution is a percentage of the account versus a fixed dollar amount, the distribution self-regulates based on the performance of the account. This helps with a volatile market, since a decline in the account value in a given year might mean a smaller distribution the next year.

So, why does this matter? Required Minimum Distributions can provide a guideline for spending, gifting, and philanthropy. If you applied the RMD factor to all of your liquid assets, you might feel more comfortable with spending more, or giving more to family or charity. For example, qualified charitable distributions (QCDs) are a common tax planning strategy. You can give up to $100,000 per year directly to charity from your IRA starting at age 70 ½ and the distribution is not counted as income. Some people may not feel comfortable utilizing this strategy for fear of drawing down their principal, but understanding how the RMD distributions look over time might help. We’ve talked before about the 4% rule in retirement^[1], but the 4% rule only applied to a 30-year time frame. Over shorter periods, a higher withdrawal rate can be sustainable. The RMD formula increases your withdrawal rate over time to account for the shorter time horizon for your retirement.

If you’re reading this and still don’t like RMDs, you might consider Roth Conversions. Roth IRAs are not subject to RMDs and grow tax-free during your lifetime, through your spouse’s lifetime if your spouse is the beneficiary and survives you, and even for 10 years after a non-spouse beneficiary such as a child inherits the account. RMDs can push you into a higher income tax bracket and increase your Medicare premiums, especially for a widowed spouse that goes from married filing jointly to single tax brackets. 

^{[1] https://twickenhamadvisors.com/blogs/unobstructed-thoughts/the-most-important-number-for-your-retirement-isnt-your-account-balance}

^{Source: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023 as of October 20th, 2023}

^{Source: https://www.medicare.gov/basics/costs/medicare-costs as of October 20th, 2023}

Roth conversions work best when you pay a lower tax rate today than you would in the future. A year in which your income is lower than usual, such as the first years of retirement, might be a great time to execute Roth conversions. Converting IRA assets to a Roth IRA reduces your IRA balance and therefore any future RMDs. Once you are over age 73, though, you must take RMDs first before executing Roth conversions, the conversion itself does not satisfy the RMD requirements.

Required minimum distributions are the price we pay for years of tax-deferred growth. They can be considered a nuisance when the distributions are greater than we need and generate a large tax bill. That being said, the RMD formula can help us incorporate life expectancy into retirement planning, particularly for spending and giving. If the growth of our investments is sufficient, the account may still grow over time, despite taking larger distributions. Individuals that want to reduce the tax bill from RMDs might consider qualified charitable distributions after age 70 ½ or Roth conversions earlier in retirement or pre-retirement.

Zeke Anders – Planning Specialist | zanders@twickenhamadvisors.com

Disclaimer

Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.