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  • Kyle Rolek, Retirement Planning Specialist

Required Minimum Distribution Planning



Executive Summary


- Required Minimum Distributions (RMDs) must be taken from pre-tax retirement accounts such as 401k accounts, 403b accounts, and Traditional IRAs once you reach age 72.


- Required Minimum Distributions generate federally taxable income. These distributions may also be considered taxable income at the state level depending on your primary residence state. In Pennsylvania, IRA distributions are not taxed at the state level.


- Required Minimum Distributions can increase your tax bracket, increase your Medicare Part B and Part D premiums, and increase the amount of social security retirement income that's subject to taxation.


- Roth contributions into retirement plans while working and periodic Roth conversions in retirement are two ways to reduce the size of future Required Minimum Distributions.


What are Required Minimum Distributions (RMDs)?


Once you reach age 72, the IRS requires a minimum amount to be distributed from pre-tax retirement accounts each year such as Traditional IRAs, 401k accounts, and 403b accounts.


If you're still working at age 72 and beyond, you don't need to take Required Minimum Distributions (RMDs) from the current employer's 401k or 403b plan. However, you still need to take RMDs from any other pre-tax retirement accounts.


Roth accounts do not have Required Minimum Distributions.


Distributions from pre-tax retirement accounts, including Required Minimum Distributions (RMDs), are federally taxable. RMDs are way for the government to raise tax revenue from retirement account money that hasn't been taxed yet.


When Do I Need to Take Required Minimum Distributions (RMDs)?


The first Required Minimum Distribution (RMD) must be taken by April 1st of the year after turning age 72. Each subsequent RMD must be taken by December 31st each year.


For example, Jane turns 72 in 2021. Jane can take her 2021 RMD any time during calendar year 2021. She can also choose to delay her 2021 RMD until April 1st, 2022.


Jane turns 73 in 2022. Jane needs to take her 2022 RMD by December 31st, 2022.


In the example above, although Jane can choose to delay her first RMD until April 1st of 2022, it will likely be financially beneficial for her to take this first RMD before the end of calendar year 2021.


If she waits until April 1st of 2022 to take her first RMD, she'll have to take both her 2021 RMD and 2022 RMD in tax year 2022.


Because RMDs are federally taxable, taking two RMDs in one tax year can increase Jane's tax bracket, increase her Medicare Part B and Part D premiums, and increase the amount of her social security income that's subject to taxation (discussed more below).


How Much Are Required Minimum Distributions (RMDs)?


Required Minimum Distributions are calculated by dividing the total value of your pre-tax retirement accounts at the prior year's end by a "Distribution Period" found on the IRS website linked here (IRA Required Minimum Distribution Worksheet: IRS.gov)


You can also use the formula (1 / "Distribution Period") to calculate an RMD percentage, then multiply the total value of your pre-tax retirement accounts at the prior year's end by the RMD percentage.


Note that for married couples, because retirement accounts can not be joint accounts, each spouse will have their own separate RMD assuming both spouses have retirement accounts.


The table below shows projected Required Minimum Distributions for someone who is 65 years old today and has $1m total in their pre-tax retirement accounts.


The first RMD is due in the year they turn age 72. The first RMD is about 3.9% of the total value of their pre-tax retirement accounts at the prior year's end. The RMD percentage increases each year as shown in the table below.


As you can also see in the table below, the first RMD is projected to be about $52k initially at age 72. It's projected to increase to over $100k by age 89!


RMD Implication #1: Tax Bracket Increase


Required Minimum Distributions (RMDs) increase income, which in turn can increase your tax bracket.


In the example above, Required Minimum Distributions (RMDs) alone will generate about $52k of federally table income in the year of their first RMD at age 72.


This income is added to other federally taxable income sources such as social security benefits, pensions (if any), dividend income, and income from part-time work. If this person is married, the spouse may also have federally taxable RMDs as well.


As you can see in the federal tax table below, a $52k increase in taxable income once RMDs begin has the potential to increase this person's tax bracket.


For example, if they have $60k of taxable income before RMDs begin, taxable income will now jump up to roughly $112k with RMDs included ($60k + $52k = $112k).


This increases the income tax bracket from 12% to 22% assuming rates for a married couple filing jointly.


The greater the size of the pre-tax retirement accounts, the greater the risk that RMDs will increase your tax bracket in retirement.


RMD Implication #2: Medicare Part B and Part D Premium Increases


Higher income can also result in higher Medicare Part B and Part D premiums in retirement.


The two tables below show Medicare premiums based on income.


Especially for those with large pre-tax retirement account balances, RMDs can trigger Medicare premium increase in retirement.


Single filers are at higher risk of Medicare premium increases because the threshold for premium increases is much lower.


Premiums don't start increasing until $176k of Modified Adjusted Gross Income (MAGI) for married couples filing jointly.


For single filers, premiums start increasing at $88k of MAGI.


Medicare Part B Premiums Increase With Income

Medicare Part D Premiums Increase With Income


RMD Implication #3: Social Security Tax Increases


The income generated from RMDs can also cause social security benefits to become taxable that weren't previously taxable before RMDs started (see this link for more details about social security benefit taxation: ssa.gov).


For married couples who file a joint tax return with "combined income" below $32,000, social security benefits aren't taxable. If "combined income" is between $32,000 - $44,000, then 50% of social security benefits are taxable. If "combined income" is above $44,000, then 85% of social security benefits are taxable.


For single filers with "combined income" below $25,000, social security benefits aren't taxable. If "combined income" is between $25,000 - $34,000, then 50% of social security benefits are taxable. If "combined income" is above $34,000, then 85% of social security benefits are taxable.


"Combined income" is defined in more detail on the social security webpage linked above.


In cases where income is already above the threshold where 85% of social security benefits are taxable before RMDs begin, then RMDs won't increase the amount of social security benefits subject to tax. This is common.


However, if you're in one of the income brackets listed above where social security benefits are excluded from tax, RMDs can cause social security benefits to become taxable for the first time.


So given all this, what can you do to reduce future Required Minimum Distributions (RMDs)?


Reducing RMDs Technique #1 - Roth Contributions


Consider making Roth contributions into 401k or 403b accounts. Roth accounts do not have Required Minimum Distributions.


This makes sense in some but not all cases. For example, here are two scenarios (with tax table shown again below)...


Scenario 1 - If a married couple's taxable income is currently $200,000 while working, they are in the 24% bracket now. If at retirement it's projected their taxable income will decline to $60,000, they'd be in the 12% bracket in retirement. It's probably best for this couple to continue saving pre-tax for now, then evaluate periodic Roth conversions in retirement when the tax rate is lower. More on periodic Roth conversions below.


Scenario 2 - If a married couple's taxable income is currently $90,000 while working and it's projected that their income will be about the same $90,000 in retirement due to social security and pension income, it probably makes financial sense for them to fund Roth now. There is no benefit to waiting until retirement to fund Roth in this scenario. Because income won't decrease much in retirement, the tax rate isn't expected to decrease either.


Reducing RMDs Technique #2 - Roth Conversions


Roth conversions allow you to move money from your pre-tax retirement accounts such as employer-sponsored 401k accounts, 403b accounts, and Traditional IRAs into a Roth IRA.


When performing a Roth conversion, tax can either be withheld from the amount converted or paid with separate funds, such as excess cash sitting in a bank account earning little or no interest.


To efficiently manage Roth conversions, a good planning technique is to convert an amount that doesn't push you into a higher tax bracket or increase your Medicare Premiums.


For example, the federal tax table above shows the 12% bracket ends around $81k for married couples. Above $81k, the federal income tax rate jumps from 12% to 22%.


Let's say a married couple has $60k of taxable income this tax year. They decide to convert $20k from a Traditional IRA to a Roth IRA this year.


Performing a $20k Roth conversion this year would successfully keep them in the current 12% tax bracket. $60k + $20k = $80k, so they're still safely below the $81k level where the tax rate jumps from 12% all the way up to 22%.


The Required Minimum Distribution (RMD) itself can not be converted into a Roth IRA.


It's often (but not always) best to start Roth conversions before RMDs begin to limit the amount being distributed from pre-tax retirement accounts and taxed in any one year.



Want To Discuss This Individually?


1 - For clients: Call or email me any time as always.


2 - For non-clients: Complete the form on the website to request a retirement planning consultation: www.rolekretirement.com



This is article is for informational purposes only and should not be considered as tax or legal advice. Advice is only provided after entering into an Advisory Agreement with the Advisor. See other disclosure here: Disclosures

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