Understanding these crucial rules can help reduce your taxes and fees.
One of the significant advantages of saving in traditional retirement accounts like a 401(k) or IRA is the immediate tax benefit. You don’t have to pay income tax on your contributions for the year you make them, freeing up cash to save more for retirement.
However, you can’t postpone those taxes indefinitely. Eventually, Uncle Sam will want his share. That’s why the IRS has established required minimum distributions, or RMDs. As suggested by the name, individuals who are subject to RMDs must withdraw a specific amount of money from their accounts. This requirement applies to anyone aged 73 or older, and can also pertain to inherited IRAs, regardless of the age of the account holder.
Missing an RMD can lead to hefty penalties — up to 25% of the amount you should have withdrawn, plus you will also need to make the distribution and pay taxes on it. Thus, it’s essential to ensure you meet your RMD obligations on time, typically by December 31 each year.
Unfortunately, rules tend to change frequently, so it’s crucial to stay updated on the latest regulations to avoid incurring a large penalty from Uncle Sam. Here are three newly updated RMD guidelines everyone should be aware of before the end of 2024.
Roth 401(k)s Are Now Exempt from RMDs
Equally important as ensuring you withdraw your full RMD on time is avoiding unnecessary withdrawals from tax-protected accounts. Every retiree should be aware that under the Secure 2.0 Act, Roth 401(k)s are now exempt from RMDs.
Previously, avoiding RMDs from a Roth 401(k) required rolling the funds over to a Roth IRA, which do not have RMDs. However, this process could mean giving up access to certain investment options available in a 401(k).
This transition also posed challenges for those who hadn’t opened a Roth IRA before. Moving funds into a new Roth IRA would put those assets under the five-year rule, meaning any earnings would be locked for five years from establishing your first Roth IRA to avoid taxes and penalties. Consequently, retirees could face restrictions on their retirement savings.
The new rule resolves this issue, allowing Roth 401(k) holders the same benefits as Roth IRA account holders.
Inherited IRA Owners May Not Have to Distribute This Year
The Secure Act introduced major changes for inherited IRAs. Instead of spreading out withdrawals across your lifetime (known as a stretch IRA), most beneficiaries are now required to take out the entire balance within 10 years of inheritance. If the original owner was already dealing with RMDs, the beneficiary must continue making those annual distributions as well.
If you inherited an IRA before December 31, 2019, you can still utilize the stretch IRA option. However, this year you must take your required minimum distribution.
The new regulation affects anyone who inherited an IRA from someone who died after December 31, 2019. Exceptions apply to spouses, children under 21, individuals with disabilities, and beneficiaries who are less than 10 years younger than the original owner.
Due to confusion surrounding the rule changes in the Secure Act, the IRS suspended the RMD requirement for newer beneficiaries from 2021 through 2024 (the Cares Act suspended RMDs for everyone in 2020). So, if you inherited an IRA from someone who passed away after December 31, 2019, you aren’t required to withdraw funds this year, even if the original account owner had RMDs in place.
However, starting in 2025, beneficiaries will need to start taking their RMDs and must still empty the entire account within a decade of inheritance. This means it might be wise to consider taking a distribution this year unless you anticipate your income (and taxes) to decrease before the ten-year deadline.
Reduce Your RMD by Up to $105,000 with Charitable Distribution
A fantastic option for retirees wishing to support charities is the qualified charitable distribution (QCD). This allows you to transfer money directly from an IRA to a qualified nonprofit, and the best part is that it counts towards your RMD. For 2024, the IRS has raised the QCD limit to $105,000 from the previous $100,000.
Remember, this rule only applies to IRAs. Funds in a defined contribution plan like a 401(k) still must adhere to RMDs.
It is important to note that you cannot use distributions from an IRA to meet the Required Minimum Distribution (RMD) obligations on your 401(k).
Making direct donations from your IRA to a charity can provide significant financial benefits. Unlike a standard IRA distribution, these donations do not count as gross income. While you could withdraw money and then contribute to charity for a tax deduction, this requires itemizing your deductions to qualify for the tax benefit.
A Qualified Charitable Distribution (QCD) allows you to donate to a charity and still take the standard deduction, so you do not lose out on tax advantages. This can lead to a lower income tax liability, lessen the amount of Social Security income that is taxable, and may lower your Medicare premiums.
You can start making QCDs at the age of 70 and a half, which is well before RMDs kick in. Even if your contributions are below the $105,000 threshold, these distributions can effectively help those who donate to charity reduce their RMDs and keep their tax burdens manageable.
The Motley Fool has a disclosure policy.
The Motley Fool is a content partner with YSL News providing financial news, insights, and commentary to help individuals manage their financial situations effectively. Its content is produced independently from YSL News.
The $22,924 Social Security bonus many retirees ignore
Offer from the Motley Fool: If you are like many Americans, you may be behind on your retirement savings. However, a few little-known “Social Security secrets” could enhance your retirement income. For instance, one simple strategy might enable you to receive up to $22,924 more annually! By understanding how to maximize your Social Security benefits, you could enjoy a worry-free retirement with greater confidence.