What Is the Required Minimum Distribution for 2021?

There have been a number of changes to the requirements for RMDs—Required Minimum Distributions—from traditional retirement accounts, says a recent article titled “2 Essential Strategies for Taking Your RMDs” from Kiplinger. In 2019, the age for RMDs was raised from 70½ to 72. In 2020, they were waived altogether because of the pandemic. Now they’re back, and you want to know how to make good decisions about them.

Most people take the default approach, taking a lump sum of cash at the start or the end of the year. This is not the best approach. Investment markets and your own need for income are better indicators for how and when to take your RMD. If you can at all avoid it, never take an RMD from a declining market.

You can take your RMD anytime during the calendar year, from January 1 to December 31. If it’s the first time you’ve taken an RMD, you get a bonus: you can wait until April 1 of the year after your 72nd birthday. The RMD is calculated, by dividing the account balance on December 31 of the preceding year by your life expectancy factor, based on your age. You can find it in the IRS’s Uniform Lifetime Table.

2021 distributions will be bigger, and not just because of the market’s 2020 performance. Instead, distributions will be bigger because of how the accounts are designed, with RMDs becoming a larger percentage over time. It starts as a small percentage and eventually becomes the entire account, which is then depleted. Remember, the sole purpose of the RMD is to force retirees to take money out of their retirement accounts and pay taxes on the money.

Many retirees take RMDs because they need the money to live on. Here’s where money management gets tricky. It’s far easier to take smaller amounts of money at regular intervals, kind of like a paycheck, than taking a big amount once a year. We’re creatures of habit and are used to receiving income and managing it that way.

Distributions on a regular basis also fosters a better sense of how much money you have to live on, encouraging you to create and adhere to a budget.

If you don’t need the income, taking money through regular installments also has an advantage. It’s like the opposite of dollar-cost averaging. Instead of putting money into the market in small increments over time to even out market ups and downs, you’re taking money out of the market at regular intervals. You’re not cashing out at the market’s lowest point, or at the highest. And if you’re reinvesting RMDs in a taxable account, this strategy works especially well.

Reference: Kiplinger (June 10, 2021) “2 Essential Strategies for Taking Your RMDs”

How Does an Inherited IRA or 401(k) Work?
Inherited IRA written on a piggy bank

How Does an Inherited IRA or 401(k) Work?

The rules for inheriting retirement assets are complicated—just as complicated as the rules for having 401(k)s and IRA to begin with. Mistakes can be hard to undo, warns the article “Here’s how to handle the complicated rules for an inherited 401(k) or IRA” from CNBC.

The 2019 Secure Act changed how inherited tax deferred assets are treated after the original owner’s death. The options depend upon the relationship between the owner and the heir. The ability to stretch out distributions across the heir’s lifetime if the owner died on or after January 1, 2020 ended for most heirs. Exceptions are the spouse, certain disabled beneficiaries, or minor children of the decedent. Otherwise, those accounts must be depleted within ten years.

Non-spouses with flexibility include minor children. That’s all well and fine, but once the minor child turns 18 (in most states), the 10-year rule kicks in and the individual has 10 years to empty the account. Before that time, the minor child must take annual required minimum distributions (RMDs) based on their own life expectancy.

These required withdrawals typically begin when a retiree reaches age 72, and the amount is based on the account owner’s anticipated lifespan.

Beneficiaries who are chronically ill or disabled, or who are not more than ten years younger than the decedent, may take distributions based on their own life expectancy. They are not subject to the ten- year rule.

Beneficiaries subject to that ten-year depletion rule should create a strategy, including creating an Inherited IRA and transferring the funds to it. If the inherited account is a Roth or a traditional IRA, the process is slightly different. Distributions from a Roth IRA are generally tax-free, and traditional IRA distributions are taxed when withdrawals occur. One point about Roths—if you inherit a Roth that’s less than five years old, any earnings withdrawn will be subject to taxes, but the contributed after-tax amounts remain tax-free.

If an heir ends up with a retirement account via an estate, versus being the named beneficiary on the account, the account must be depleted within five years, if the original owner had not started taking RMDs. If RMDs were underway, the heir would need to keep those withdrawals going as if the original owner continued to live.

For spouses, there are more options. First, roll the money into your own IRA and follow the standard RMD rules. At age 72, start taking required withdrawals based on your own life expectancy. If you don’t need the income, you can leave the money in the account, where it can continue to grow. However, if you are not yet age 59½, you may be subject to a 10% early withdrawal penalty if you take money from the account. In that case, put the money into an Inherited IRA account, with yourself as the beneficiary.

IRAs and 401(k)s are complicated. Speak with your estate planning attorney to make an informed decision when creating an estate plan, so your inherited assets will work with, not against, your overall strategy.

Reference: CNBC (April 11, 2021) “Here’s how to handle the complicated rules for an inherited 401(k) or IRA”