Required Minimum Distributions

If you inherited an IRA or are over 72, you have to take distributions and the penalty for not taking enough is terrible. In this episode we talk about the ins and outs of required distributions.

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Full Transcript below:

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Speaker 1 (00:08):

Welcome back to 30 Minute Money, the podcast that delivers action-oriented smart money ideas and bite-size pieces. I am Scott Fitzgerald at Roc Vox recording and production with Steve Wershing from Focused Wealth Advisors.

Speaker 2 (00:21):

Hey Scott,

Speaker 1 (00:21):

How you doing?

Speaker 2 (00:22):

I'm doing well. How are you?

Speaker 1 (00:23):

Alright. Did you light the scented candle yet or no? You want to leave that off?

Speaker 2 (00:27):

We can leave that off until we get the SMELLOVISION radio then we can not have to worry about that.

Speaker 1 (00:33):

I just thought maybe it would enhance the mood for talking about financial

Speaker 2 (00:36):

Things. It's all about mood, Scott. It's all about it. So could you, in fact, I was meaning to tell you, would you lower the lighting a little in here please? You

Speaker 1 (00:43):

Want, okay, cool.

Speaker 2 (00:44):

Yeah.

Speaker 1 (00:44):

And we have a little background music.

Speaker 2 (00:46):

Exactly.

Speaker 1 (00:46):

Exactly. Alright, so RMDs as opposed to WMDs.

Speaker 2 (00:51):

That's right.

Speaker 1 (00:53):

Rmd.

Speaker 2 (00:55):

There's a Well, interesting, you should bring that up because we call RMDs the time bomb.

Speaker 1 (01:00):

Oh,

Speaker 2 (01:01):

Oh yeah. So we're going to talk all about required minimum distributions today, and we're here in the fourth quarter and we're coming up on the end of the year. And there are really important things, if you are of the age where you need to take money out of your retirement plan, this is something you're going to want to know before the end of the year. So that's why I wanted to talk about this today. So retirement plans are a great deal that you get to earn money and put it into something that you can save for your retirement and you don't have to pay taxes on it then. And you can leave it in there for years and years and it can grow like crazy without being taxed. But at some point the IRS is going to get their pound of flesh. And so they're going to say, okay, we've waited long enough, you're going to start paying some tax on some of this stuff. And that's what a required minimum distribution is that once you get into your seventies, you have no choice. You have to take out at least a certain amount every year from your retirement accounts.

Speaker 1 (02:03):

And they've changed this a lot.

Speaker 2 (02:05):

They have. So

Speaker 1 (02:07):

You really have to know. You got to know exactly. Well, obviously you have to know exactly when you were born, but it changes between when you were born and when you get a certain age, all these. So it's not the same for everybody.

Speaker 2 (02:18):

It's not. And you're right, it's confusing because it's changed a few times over the past few years. So if we go back more than before 2019, you had to start taking required minimum distributions when you were 70 and a half. And I want to be, I am just picturing this maniac in the basement of the executive office building in Washington, thinking up these rules like, well, I got it, I got it. We'll make it 70

Speaker 1 (02:45):

And a half. Get it. It's because he has a five-year-old and the five year old

Speaker 2 (02:49):

Is all or something like that. Exactly.

Speaker 1 (02:51):

That's the only time you ever think about it.

Speaker 2 (02:53):

And reading some of these regs, I wouldn't be surprised if there was a five-year-old writing him. So you may have a point there. Anyway. So before 2019 you had to start taking money out when you were 70 and a half with the secure act in 2019, they raised that to 72, which was a nice round number. Thank you very much. And then with the secure Act 2.0, they raised it again so that if you were born between 1951 and 1959, you have to start taking them at 73. And if you were born 1960 or later, then you have to start taking them when you are 75. So like you said, Scott, not everybody has to take 'em out at the same age, depending on when you were born, you'd take 'em out at different times. But those are the ages currently 73 or 75.

Speaker 1 (03:43):

And it makes sense now that they've made it a later an older age. People we're living longer and we're looking at

Speaker 2 (03:52):

That's right. Yeah, exactly. And it's nice because it gives us more time to plan. We'll talk about that a little bit later, but that's when people have to start taking 'em now. So when you turn, whatever that age is, 72, 73, 75, then you need to take a certain minimum out. The minimum changes every year. It's based on a life expectancy table. So in the year when you have to start taking them, you take the balance of your account on December 31st of the prior year and you divide it by a life expectancy factor. And that's how much you have to take in that year. And so like I said, it changes every year because that factor changes every year. Every year you get older, your life expectancy changes a little bit different denominator, different amount. And so that's how much you have to take each year.

Speaker 1 (04:43):

The math is going to mess me up here, but can you give me an example?

Speaker 2 (04:47):

Sure. So when you turn 72, the factor is 26.4. So if you have a hundred thousand dollars in your IRA at the end of the prior year, then you take a hundred thousand, divided it by 26.4, roughly 4% of your account. That's how much you have to take out the next year. That's your required minimum.

Speaker 1 (05:06):

Got. Alright. So how are you avoiding taxes on this stuff?

Speaker 2 (05:12):

Well, we'll get to that in a second. Mind

Speaker 1 (05:13):

Jumping the gun.

Speaker 2 (05:14):

What I want to talk about first is why it's so important to take it out. So you have to take out whatever that minimum is, but it's really, really important that when you need to take it out and how much you need to take out. Because if you don't take it out on time, the penalty is huge. Now, it used to be that the penalty for not taking sufficient required minimum distributions was 50% of the distribution. So if you had to take a thousand dollars out in a year and you didn't went into the next year, the penalty tax was 500 bucks,

Speaker 1 (05:51):

That's a hell of a hand slap.

Speaker 2 (05:53):

It's crazy. I can't even think of an adjective to put on it. It's insane. And if you didn't take out enough, then you'd have to pay that penalty tax on the amount that you should have taken that you did not. So if you needed to take out a thousand and you actually took out 500, you had to pay the penalty tax on the 500. Now in secure 2.0, they lowered that thankfully, but it's still 25% if you don't take it out on time, it's a 25% tax on that. Now, if you miss it and you catch it fast enough, which usually means before filing date the next year and you catch it before the IRS does, then they will lower that to 10%. But I mean still 10% is still a pretty big tax

Speaker 1 (06:37):

Penalty,

Speaker 2 (06:38):

So you have to pay the tax on it and then you've got to pay the penalty on it. So it's really important that if you are 72, 73, 75 this year, it behooves you to know how much you have to take out and that you make sure you do it before December 31st because the price is pretty steep. If you don't.

Speaker 1 (06:57):

Now, how many people actually, so obviously this is what you do, this is how people trust you and say, Steve, you got my back. You're the one that's going to say, Hey, you've got to do this. Are there some people who just try to think maybe they can do it themselves and they forget? And I mean, is that a common thing?

Speaker 2 (07:15):

Well, it's possible. What's good though is that most every institution that sponsors IRAs, they've got it programmed into their system. So you're going to get a notice, you're going to get a notice, or chances are, if you don't respond to anything or if nothing else happens, you're going to get a check in the mail, which is fine because they will take care of it for you.

Speaker 1 (07:38):

Oh, okay.

Speaker 2 (07:39):

But depending on what your, if you're with Fidelity or Schwab or a big bank or a mutual fund company, they'll automatically send it out to you, but you still want to pay attention to it. If you've got a lot of IRAs in different places or then there's all the rules about beneficiary IRAs. That's going to be a separate podcast episode. But if you inherited an IRA, there's all kinds of rules that you should know. Some of them regard required minimum distributions and those required minimum distributions just as a teaser for that other episode, don't depend on your age. They depend on the age of the person who passed away and left it to you. You could be a 50 year old and still have to take required minimum distributions if your 80 year old father passed away, for example, and left you an IRA. But again, there are enough things I want talk about that we'll make it a separate episode.

(08:30):

But there are people, there are institutions that are looking out for you. It's still good to know because again, if you've got IRAs in a bunch of different places or potentially in a smaller institution or something, it's a very steep price to pay if you miss it. So there are a few ways of being able to avoid some taxes on required minimums. One of the challenges with required minimums is it makes tax management more difficult because it's one of those things that you lose some control over, right? It's like you can't leave something someplace where it's not going to cause you tax. So there are a couple of ways that you can avoid taxes on it. One of them, which a lot of people may not realize is something called the qualified charitable distribution or the QCD qcd can be great tools because, well, I'll give you a great story, perfect example of this. I have clients and one of the clients turned RMD age a couple of years ago, so he's taking his second or third RMD, and it hadn't really occurred to me to ask, but their accountant goes to the same church as they do, and it's one of the Christian faiths, the tithes. So a certain portion of their income they send to their church, it's part of their obligation, it's part of their religion. And

Speaker 1 (09:48):

That word is tithe. Is that what?

Speaker 2 (09:50):

Yep, tithe. So if you are a Christian denomination and you tithe, churches are tax exempt organizations, and so you can use it like you would contribute to a charity. And so the accountant called me and he said, Hey, he has to take his RMD this year, but they give this much to their church every year. And a light bulb went off. And so I called 'em and said, Hey, you can take your required minimum distribution, not have to pay tax on it because it's money that you're going to pay anyway. They were giving a certain percentage of their income to the church every year. We just shifted it from their bank account to their IRA and voila, we just bypassed all the tax on that part of the RMD. But if philanthropy is part of your normal core, if you give a certain amount of what you make every year to charitable causes or those kinds of things, and you get to RMD age, make it out of your RMD because that way you don't have to pay tax on it.

(10:49):

And these days, because charitable contributions, we don't get the tax benefit that we used to get for most people because you don't get the benefit unless you itemize your deductions. And with the standard deduction being as high as it is, a lot of people don't itemize. And so if they give money away, they don't necessarily get a tax break for it anymore like they used to. But now if you're taking RMDs and you just direct it to the charity, then you don't get taxed on that. So it's a way to get the tax benefit that you might've lost when they increase the standard deduction.

Speaker 1 (11:20):

So when you say itemize, does that mean you're saying specifically where it's going or what does that mean?

Speaker 2 (11:25):

No, itemizing your deductions means that, so you fill out the first two pages of your 10 40, and so you list all your sources of income and that kind of stuff, but then there may be things that happen over the course of the year that you can deduct from your taxes. But in order to do that, you can't take the standard deduction. Standard deduction sort of is a blanket. We're not going to make you work to account for all this stuff. We're just going to let you take, in this case, if you're a married couple filing jointly in 2023, that standard deduction is $27,700. So we're not going to make you list all this stuff. Charitable contributions, certain kinds of taxes, certain kinds of expenses. You don't have to do that. You can just take 27 7 off your taxes. So you don't really get the benefit.

(12:10):

So if you're taking the standard deduction and you're not itemizing, you're not filling out that schedule A, then you're making the deduction, but you don't really get the benefit from it because taking the standard deduction. So this is a way of avoiding the tax on that if you're not itemizing. Now, some people might think that they can take the required minimum and convert it to a Roth IRA because of course we talk a lot about converting money from a traditional IRA to a Roth IRA required minimum distributions are not eligible for Roth conversions. So you have to take it, you have to realize the tax on it, but then you also cannot turn around and dump it into your Roth IRA. That has to be separate money. So if you're getting an RMD and you want to do a Roth conversion, you're going to have to pay tax on both. So a lot of people say, oh, I can figure this one out. I'll take my RMD and then I'll just put it in my tax-free bucket. I wish it worked like that, but unfortunately that is not something that's open to you.

Speaker 1 (13:11):

They're sneaky.

Speaker 2 (13:13):

We have a whole industry of people who are thinking of the loopholes and trying to figure that out. But yeah, they'll figure out the most obvious loopholes and cut those off. So yep, they're not going to let you do a Roth conversion on your required minimum, unfortunately would've been great. I'm all about getting more from the deferred bucket into the tax-free bucket, but unfortunately that's one that won't work.

Speaker 1 (13:34):

Well, I guess I'll take that off my list of things I'm trying to do.

Speaker 2 (13:37):

Right? Exactly. But however, I mean, if you really want to reduce your required minimum distributions and save money that way, the best way is to plan far ahead of time. So if you are in your sixties or even your fifties, you've tuned out this episode long ago, but the real secret to doing this is working as far ahead as you can to balance the different buckets and systematically move money from the deferred bucket to the tax-free bucket. Because the smaller you can make that deferred bucket, the smaller your required minimums are going to be. And in my world, Nirvana, the place where you really want to get is when your required minimum equals your standard deduction. If you can get down to the point where your required minimum is less than your standard deduction, they wipe each other out and you don't have to pay tax on it. But most people can't get quite down that far because that means you've shifted a lot from your deferred bucket over to your tax free bucket. But if we could aim for one thing, that would be it.

Speaker 1 (14:35):

That sounds like another podcast episode to discuss ways to do that or have we already

Speaker 2 (14:41):

Done. That's what we do every episode, Scott. But

Speaker 3 (14:49):

Your retirement is at risk, not from the stock market, not from inflation. Taxes are putting your retirement at risk. I'm certified financial planner, Steve Waring and I specialize in helping people create low tax retirements. Unmanaged taxes can take 30, 40, even 50% of your retirement income. Learn how to defend yourself against excess taxation. Our complimentary webinar will cover all the principles you need to know to protect your money for you and your family and keep it away from the government. This free webinar will cover how taxes are different in retirement, the taxes you pay in retirement that you don't have to pay during your working life, how to move savings into a tax-free environment, the Widows Tax, the Secure Act, the Secure Act 2.0 and what they mean to you. The webinar is free, but you have to register to save your spot. So go to focused wealth advisors.com/webinars and find out more and sign up right there. Even if you're not planning to retire for the next five or 10 years, this information will be critical for you. The longer you have to put the strategies into effect, the more you can accomplish. That's focused wealth advisors.com/webinars to find out more and to sign up today.

Speaker 1 (16:14):

Alright, so what's your 30 minute action item?

Speaker 2 (16:17):

30 minute action item is know when you have to start, but look at the calendar and make sure you know when you have to start your required minimums so you can talk to your advisors and make sure you take enough.

Speaker 1 (16:28):

All right, well, the RMD time bomb right here for you. 30 minute money. 30 minute money. That's three zero minute dot money. I got it this time. You got it. And of course, Steve Wershing from Focused Wealth Advisors, you can check out their Tuesday webinar at focusedwealthadvisors.com and we'll see you next time on 30 Minute Money.