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Avoid Overpaying Retirement Taxes: Recognizing and Preventing Seven Common Mistakes with Required Minimum Distributions (RMDs)

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Avoiding Costly Retirement Tax Errors: Identifying and Preventing typical RMD oversights
Avoiding Costly Retirement Tax Errors: Identifying and Preventing typical RMD oversights

Avoid Overpaying Retirement Taxes: Recognizing and Preventing Seven Common Mistakes with Required Minimum Distributions (RMDs)

In the complex world of retirement planning, understanding the intricacies of Required Minimum Distributions (RMDs) is crucial. The recently enacted SECURE 2.0 Act has introduced changes that could significantly impact how retirees and beneficiaries manage their RMDs.

Common Mistakes and Their Tax Implications

  1. Missing the RMD Deadline: RMDs must be taken by December 31 annually, or April 1 for the first RMD. Failure to withdraw the required amount results in a penalty excise tax of 25% of the amount not withdrawn, reduced from 50% under prior law per SECURE 2.0. If the mistake is corrected timely (within two years), the penalty can drop to 10%. Income tax on the withdrawal amount still applies.
  2. Misunderstanding the Changed RMD Age: SECURE 2.0 increased the RMD starting age to 73 beginning January 1, 2023, and to 75 beginning January 1, 2033, for most individuals. Failing to start RMDs at the correct new age can trigger penalties.
  3. Ignoring Inherited IRA RMD Rules: Beneficiaries must usually withdraw inherited IRA amounts within 10 years of the account owner's death. Missing these RMDs leads to the same 25% penalty as with personal RMDs.
  4. Assuming No RMDs Due to Working Past RMD Age: The exception to delay RMDs while still working only applies to the current employer’s retirement plan, not IRAs or prior plans. Misapplication causes missed RMDs and penalties.

Additional Considerations

  1. Qualified Charitable Distributions (QCDs): Some retirees don't know they can fulfill their RMD by making a QCD directly from their IRAs to a qualified charity. By doing so, retirees can support charitable causes while minimizing the impact on their taxable income.
  2. Medicare Premiums and Modified Adjusted Gross Income (MAGI): Your MAGI in retirement can also increase Medicare premiums and limit eligibility for certain deductions and credits.
  3. Market Downturns and RMDs: Market downturns might impact your RMD, and not adjusting for upswings could lead to insufficient withdrawals and associated penalties.
  4. RMDs from 401(k) Plans: RMDs from 401(k) plans must be calculated and withdrawn separately for each account, not combined with RMDs from IRAs.
  5. High Taxable Income: High taxable income in retirement can impact taxes on Social Security benefits and push retirees into higher tax brackets.
  6. Portfolio Value Changes: Not accounting for significant changes in your portfolio's value in volatile markets could lead to miscalculations.

Given the complexity of RMDs, it's essential to consult a financial adviser or tax professional to ensure a thorough understanding of how these rules impact you. With careful planning and timely action, retirees and beneficiaries can navigate the RMD landscape effectively and avoid costly penalties and tax implications.

[1] Investopedia. (2022). Required Minimum Distributions (RMDs). [online] Available at: https://www.investopedia.com/terms/r/requiredminimumdistribution.asp

[2] IRS. (2022). Retirement Plans FAQs regarding the SECURE Act. [online] Available at: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-the-secure-act

[3] AARP. (2021). How the SECURE Act 2.0 could affect your retirement. [online] Available at: https://www.aarp.org/retirement/social-security/info-2021/secure-act-2-0-what-you-need-to-know.html

[4] Forbes Advisor. (2021). SECURE Act 2.0: What Changes Could Affect Your Retirement Accounts? [online] Available at: https://www.forbes.com/advisor/retirement/secure-act-2-0-changes/

[5] Kiplinger. (2022). SECURE Act 2.0: What You Need to Know. [online] Available at: https://www.kiplinger.com/retirement/retirement-planning/603671/secure-act-20-what-you-need-to-know

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