Large retirement account balances can cause tax problemsPutting off distributions and holding assets in your retirement accounts as long as possible may seem like a good idea, but waiting too long can cause a major tax problem. When you reach age 73, the trigger requiring minimum distributions (RMDs) from qualified retirement accounts is initiated, potentially causing unwanted tax obligations.
RMDs explained Required minimum distributions is a formula applied to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k), 403(b) and other defined contribution plans that calculates how much you must withdraw from your retirement accounts each year. If you fail to take out the minimum distributions, amounts not distributed on a timely basis can be subject to a 25% penalty (or 10% if the problem is corrected within two years). ALERT: Prior to 2023, the RMD penalty was a whopping 50%! Thankfully, there are other beneficial rule changes that impact required minimum distributions: No distributions required while you are still working. You may now delay withdrawing funds from employer plans like a 401(k), past age 73 as long as you are still working and are not a 5%-or-greater owner of the company. RMD rules are different for Roth accounts. Roth IRAs are not subject to the RMD rules while you are still living. And beginning in 2024, Roth 401(k) and Roth 403(b) minimum withdrawals are not required. The RMD rules ensure the deferred tax benefit for certain retirement accounts does not extend indefinitely into the future. In other words, the IRS wants their cut by applying income taxes to your tax-deferred savings account balances. The amount you must take out each year is based upon your age, your spouse’s age, and your filing status. The tax planning opportunity If you wait to start taking money out of your retirement accounts, the balance in your accounts may be very high when you reach age 73. These higher balances mean a higher annual taxable withdrawal amount. If your required retirement plan distribution is large enough, it may apply a higher marginal tax rate on your withdrawals, and trigger taxes on your Social Security benefits. Depending on your income and filing status, up to 85 percent of your Social Security benefit can be subject to income tax. The key is to be tax efficient in your withdrawals every year, and long before the required minimum distribution rules take away your planning flexibility. Some tips
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September 2023
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