If you’re not aware of recent rule changes, you might be missing out on substantial savings or even risk costly penalties.
When it comes to preparing for retirement, funneling your savings into a 401(k) or IRA stands among the most effective strategies. Each year you contribute to these accounts, the government grants you a tax deduction equal to the amount invested. Plus, any dividends or capital gains earned within these accounts remain tax-free as long as the funds aren’t withdrawn. This setup often encourages investors to keep their retirement savings untouched and allowed to grow over the years.
Eventually, though, Uncle Sam wants his cut. That’s where Required Minimum Distributions, or RMDs, come into play for traditional 401(k) and IRA accounts. Once you hit the current threshold of 73 years old, the IRS mandates you withdraw a specific portion of your retirement savings annually and pay income taxes on it. If you’ve inherited an IRA from someone who was subject to RMDs, you might also need to continue these withdrawals yourself.
Failing to withdraw the required RMD can trigger a penalty of up to 25% of the amount that should have been withdrawn. On top of that, you’d still have to take out the correct amount and pay taxes on it. Thus, understanding these rules is crucial. RMD regulations have evolved significantly recently, and by 2025, more changes are expected that everyone should be aware of.
1. Roth 401(k) Accounts Are Now Exempt from RMDs
Thanks to the SECURE 2.0 Act, this change took effect in 2024. With an ever-increasing number of people opting for Roth 401(k)s, it’s important to note that these accounts are no longer bound by RMDs.
In the past, Roth 401(k)s required RMDs much like their traditional counterparts. Although such withdrawals didn’t result in income tax, they did cut short the tax-free growth of the investments. One workaround was rolling a Roth 401(k) into a Roth IRA. However, new Roth IRA account holders could be subject to the five-year rule, which limits the withdrawal of earnings within the first five years of account creation. This could prevent you from pulling out as much as you want from your Roth IRA, while keeping it in a Roth 401(k) might force you into larger-than-desired withdrawals.
The new guideline aligns Roth 401(k) accounts with their Roth IRA counterparts, eliminating the worry of RMDs for those who favor the Roth 401(k) for their primary savings.
2. More Inherited IRAs Will Require RMDs
If you took ownership of an IRA from someone who passed away post-Dec. 31, 2019, you might need to undertake RMDs starting in 2025.
The SECURE Act introduced a rule compelling most IRA beneficiaries to deplete the account within a decade. Previously, it was unclear whether someone inheriting an IRA from an account holder already subject to RMDs needed to continue these withdrawals, given the 10-year depletion requirement. RMD requirements were temporarily lifted from 2021 to 2024, including an exception for 2020.
But here’s the scoop post-July IRS ruling: Most inheritances will involve annual RMDs beginning in 2025, going forward. This applies if the original owner passed after reaching the distribution age. The decade rule remains, meaning beneficiaries have to exhaust the account within 10 years of inheritance.
For many, spreading out a smaller annual distribution rather than facing a hefty tax bill from a large, one-time payout in the 10th year could be financially smarter. Still, the loss of postponing withdrawals in high-income years might be a downside for some heirs.
3. Reduce Your RMD by Donating Up to $108,000
A notable adjustment by the SECURE 2.0 Act is inflating the qualified charitable distribution allowance annually. Come 2025, individuals aged 70½ and older can directly donate up to $108,000 from their IRAs to charitable organizations, which can count toward their RMD.
However, take note: Qualified charitable distributions (QCDs) apply strictly to IRAs. Other retirement savings aren’t off the RMD hook unless shifted into an IRA. Also, the cap is individual-based, so couples might donate a combined total of $216,000 in a year but can’t cover a spouse’s RMD via a larger QCD from one IRA.
For the philanthropic minded, a QCD is a savvy way to contribute. Such distributions are excluded from your adjusted gross income, unlike regular withdrawals. Plus, there’s no need to itemize to gain the tax perks. It can result in significant financial savings since your adjusted gross income influences Medicare Part B premiums and the taxable portion of Social Security benefits. Often, the standard deduction (set at $33,200 for a couple over 65) surpasses itemized deductions combined.
Even if you don’t intend to max out the $108,000 QCD ceiling per person, utilizing it remains a solid strategy to contribute and lessen your RMD.
