If you’re 72 or older, you have a crucial financial deadline approaching.
By year-end, owners of individual retirement accounts (IRAs) who are 72 or older must take their required minimum distribution (RMD) before the Dec. 31 deadline, or face a possible IRS penalty of 50% of the amount not withdrawn in time.
The penalty for ignoring an RMD is 50% of what was supposed to be withdrawn – for example, someone whose RMD was $1,000 would face a $500 penalty on top of their RMD. Someone who takes a partial distribution would still pay the fine, so in the previous example, if the taxpayer took only $500 of the $1,000 he was supposed to take, he’d face a $250 penalty.
Apparently, there’s a large number of older adults waiting until the last minute.
As of Nov. 11, Fidelity Investments, estimated it has 1.5 million customers who fell into this category, representing a total of $21.5 billion in retirement funds, with $1.8 billion in retirement funds for individuals taking an RMD for the first time.
Of that total amount, about 31% of Fidelity’s RMD-eligible IRA customers had not taken any amount from their Fidelity IRA(s) toward satisfying their RMD for 2022. In addition, another 27% had only taken a portion of their RMD for 2022, Fidelity said.
Fidelity said the trends are not unusual as people often wait to see how the stock market performs throughout the year, while others forget or don’t have pressing needs for the money, said Sham Ganglani, Fidelity’s director of retirement.
“Most investors defer as long as they can,” agreed Rob Williams, managing director of financial planning at Charles Schwab.
Why do people wait?
“People wait because they hope the stock market might go up and they want to keep their money in longer to grow. This year, the market went down so waiting didn’t help,” said Kelly Webber, Vice President and Director of Trust Administration for Spinnaker Trust. “It’s so hard to time the market. It makes sense to spread the distributions throughout the year.”
“Waiting also can cause delays because financial institutions can get really busy in November and December with year-end planning and gifting needs. That, combined with the holidays can make it really busy. You want to make sure you don’t miss the deadline, so don’t wait until the winter months,” Webber said.
The Internal Revenue Service requires people over age 72 to take an RMD each year from traditional IRAs (including rollovers and SEPs), as well as from Simple IRAs. You pay taxes on the RMD amounts.
RMDs are based on the account balance as of Dec. 31 of the prior year. For example if you have a traditional IRA account, your balance as of Dec. 31, 2021 was used in calculating your 2022 RMD. The overall RMD is calculated based on account balance and life expectancy.
The exception is if this is your first RMD. You are allowed to defer taking your first RMD until April 1 of the following year. For those turning age 72 in 2022, they can defer their first RMD until April 1, 2023.
However, that means you’d being taking two RMDs in one year, potentially bumping you up to a higher tax bracket and forcing you to pay more in taxes, Webber said.
While the rules can seem confusing, there are RMD calculators connected to various brokerage firms and your own financial firm should alert you about your expected RMD. Many customers choose to set up automatic withdrawals in order to avoid missing the IRS deadline.
Fidelity said it reminds clients to sign up for a free automatic RMD withdrawal service, allowing people to choose a schedule and automatically calculating the RMD amount, and then making the withdrawal and distributing funds where and when desired. This year, Fidelity said it has seen nearly 45% of eligible customers utilize this free service.
For investors looking for ways to lower their taxable income, or simply be charitable, consider a qualified charitable distribution (QCD). For investors age 70½ or older, up to an aggregate amount of $100,000 can be donated to a favorite qualified charity.
That amount would count toward the RMD for the year once you reach the age of 72 and are eligible. It can also be excluded from taxable income and investors don’t need to itemize deductions to do so.
But keep in mind, in order for a QCD to count toward the current year’s RMD, the funds must come out of the IRA by the RMD deadline.
“A qualified charitable distribution is a powerful way to combine tax advantages with giving you would do anyway. It’s an attractive strategy,” said Schwab’s Williams, who cautioned that the QCD must go directly to the charity and not pass through the investor’s hands.
RMDs are subject to federal income taxes at ordinary income-tax rates. RMDs from Roth 401(k)s are not taxed as long as they meet the requirements for a qualified distribution including having met the five-year rule for Roth contributions.
For inherited IRAs, the RMD rules are complicated and can vary based on when you inherited the plan, when the original owner died, and your relationship to the original owner of the account. The rules governing inherited IRAs may change with the SECURE 2.0 provision in Congress, which would affect future year RMDs.
“Get help even if you don’t think you need it,” Williams said. “Inherited IRA rules are very complex. Get help and do it before year-end.”