Qualified Withdrawals in Retirement
Retirement can be both exciting and a little scary. Hooray, no more clocking in for the 9 to 5 grind! However, you won't be receiving a steady paycheck either. That's a serious bummer.
At this point in your life, to supplement your lack of pay, you may be thinking about accessing some of the money you have in retirement accounts.
If you have attained age 59.5, you are eligible to take penalty-free withdrawals from your retirement accounts including IRA, 401(k), 403(b), etc. If you withdraw funds before your RMD age (73), it will be considered an ordinary distribution.
How much is the right amount?
To calculate Required Minimum Distributions (RMDs), you can check free online tools like the AARP calculator or the worksheet provided by the Social Security Administration. If you are apprehensive about the DIY approach to Required Minimum Distributions, contact a Certified Financial Planner.
The minimum amount you can withdraw
At age 73, there is a minimum amount you must withdraw annually from retirement accounts. This is called your Required Minimum Distribution or RMD. Failure to take your RMD, results in a hefty penalty by the IRS. This penalty is used to represent a 50% excise tax on the amount not withdrawn. However, there is good news, The SECURE Act 2.0 reduced this penalty from 50% down to 25%. This is still a huge fine for breaking the rules, so approach annual withdrawals with caution.
Maximum withdrawal amount
As previously mentioned, if you are age 59.5 or older, you are eligible to take penalty-free withdrawals. You can withdraw up to 100% of your retirement account value. However, is this a good idea? Not necessarily.
This can come as quite a shock to retirees, but any qualified withdrawals; either ordinary distributions or RMDs, will be taxable. Uncle Sam has been allowing your retirement accounts to grow tax-deferred during your contributing years, but once you take a qualified distribution, withdrawals will be taxed.
The greater the withdrawal amount, the more likely you are to push yourself into a higher tax bracket.
Below is a 2024 Tax Bracket grid.
Understand Tax Bracket Calculations
Federal taxes are calculated on what is called a Progressive rate. In other words, in blocks, you are taxed by the bracket relative to income.
This is how it works. Hypothetical Betty is age 75 and single. She has $78,000 per year in income. A portion of this income is from RMDs taxed as ordinary income.
Using the 2024 tax bracket grid as her guide, Betty sees she will taxed in the following manner:
10% on her first $11,600 of income
12% for the amount between $11,601 - $47,150
22% for the remaining $30,849 ($78,000 - $47,151)
Lowering tax obligation
What can taxpayers do to lower their tax bill?
Those who qualify can make a tax-deductible IRA contribution.
Tax credits provide a dollar-for-dollar reduction
Qualified Charitable Deductions (QCDs) can replace RMD obligations. Instead of taking annual RMDs, taxpayers can elect to make distributions directly to a charity of their choosing. As long as they do not take possession of the withdrawn funds, but instead route the distribution to their charity, this is not considered a taxable event.
Other RMD considerations
Aggregation rules can be applied to RMDs. When aggregating RMDs, the taxpayer can elect to take their RMD from only one source.
Here is an example. Hypothetical Betty, who is age 75, has a 10,000 IRA account at her bank and another $50,000 IRA at her investment company. Between the two IRA accounts, she can withdraw funds based on the aggregated total of $60,000 in IRA holdings. She can elect to remove the funds from one or both accounts, the choice is up to her.
However, only like-titled accounts can be aggregated for RMD purposes. In a second example, Hypothetical Betty, age 75, has $10,000 in an IRA at her bank and a 401(k) through her former employer. Both the IRA and the 401(k) are retirement accounts. Betty must take the Required Minimum Distribution (RMD) withdrawals from the two accounts separately. Because one account is an IRA and the other is a 401(k), they are not like-titled and can not be aggregated!
Conclusion
As you approach retirement and before age 73, it is time to learn about your qualified withdrawal options. Withdrawals from most retirement accounts result in a taxable event. Unlike traditional retirement accounts, withdrawals from Roth retirement accounts are tax-free as long as certain requirements have been met.
Failing to meet RMD withdrawals in the year that tax is due results in large penalties. Understand your tax bracket and learn what you can do to reduce your taxable situation. Aggregation rules apply to RMDs.
To be sure you have planned for and will properly meet your Required Minimum Distribution on all of your retirement accounts, contact Marianne Nolte, CFP® for a complimentary consultation.
About the Author
Marianne Martini Nolte, CFP® provides tax-savvy wealth management for women and a few cool men.
View our Services & Fees HERE
CLICK HERE to book a free consultation.
Subscribe to the Imagine Financial Services monthly Newsletter HERE.
References
Parys, S., & Orem, T. (2024, March 12). 2023-2024 tax brackets and Federal Income Tax Rates. NerdWallet. https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets#2024-tax-brackets-and-income-tax-rates
