Retirement account Required Minimum Distributions (RMD)

The Pub
1

I brought this up in another thread so figured it might be better to pull it out in case anyone was interested.

Recently I was eyeballing a retirement and I had not considered RMDs. Basically a Required Minimum Distribution is an amount you must withdraw from your taxable retirement accounts at age 72. Since retirement accounts are individual, a married couple’s accounts will not be combined for RMDs. If one spouse is two years older than the other, the first will reach 72 and have a RMD and then the other will have their first RMD two years later.

Currently the first RMD at age 72 is roughly 1/27th. So if you have $270,000 in retirement at age 72 you will have to withdraw $10,000.

If you’ve not contributed heavily toward retirement the RMD will not be a large amount. If you have contributed heavily in a taxable retirement account then you should consider converting to Roth to avoid potentially moving into a new tax bracket during retirement.

Let’s discuss Roth for a second. Any conversion prior to age 59 1/2 requires you to pay the taxes out of other funds to avoid penalty. Once you reach 59 1/2 you could withdraw funds, and pay taxes on those funds, and use those funds you withdrew to pay the taxes on the conversion. Any converted Roth starts a 5 year clock where those funds cannot be withdrawn without penalty.

So let’s run an example. Someone who is 50 who started contributing in 401k at age 25. Let’s say their total contribution (employee & employer) has been $10k each year. So they have contributed $250,000 in total. Now let’s say they averaged the same as the historical stock market return, 10%. Today they have roughly $1,150,00 in the account with 22 years until they reach the age of RMDs. If they didn’t contribute another dime and didn’t withdraw any funds they would have over 9 million at age 72 with their 10% return. The RMD that year would be over $300k.

Anyone with a taxable retirement account knows they will one day owe taxed on the funds. I would wager most thought they would drop into a lower tax bracket, but it could be the opposite and they could find they are in a higher tax bracket. So if you thought you would be in say a 12% bracket (2021 individual <10k 10%, 10k-40k 12%), that $300k RMD would put you into the 35% bracket (40k-87k 22%, 87k-165k 24%, 165k-210k 32%, 210k-524k 35%).

My suggestion would be to take a look at your retirement accounts and see where you might be at the age of RMD. Then develop a strategy to convert taxable retirement funds to Roth while in a lower tax bracket to avoid a future higher tax bracket.

2

Good post, but those are the single filing rates, vs married filling jointly rates.

3

Correct. I did it that way since retirement accounts are individual. If both spouses work and both contributed similarly it could be a 2X situation.

I also skipped considerations of deductions, SS, and pensions.

I didn’t start contributing early because I didn’t enter the workforce until after grad school and my first employer started a 401k in my last year with them. My next employer started one in my second year with them. Eventually I realized I should max out the contributions, and I did so, often at the expense of current lifestyle so we’ve lived modestly and have been extremely frugal. I recently realized with my wife’s pension, her SS, my SS, and our retirement funds I can step out as soon as the retirement funds are available. It’s refreshing, but then I discovered I won’t be in a lower tax bracket and may potentially be in a higher tax bracket unless I convert funds strategically.

4

I would just add: These withdrawals are mandatory and violations incur severe penalties, so it’s important to prepare and have a plan.

5

This is the part that you can’t just gloss over. If you retire at 59.5, 62 or even 65, you will likely be reducing the balance in your retirement accounts by a significant amount before you hit 72. I can’t see myself having a higher income in the years where I need to start taking RMD’s than I do now at the peak of my earning. Tax-deferred savings lets me control my money up until the time I actually choose/have to start withdrawing and paying taxes, plus it reduces my taxable income in the current year.

6

BUT…

For the example they only contributed 10k each year.

If they actually contributed more then at age 50 they could potentially have 2X or 3X the amount in my simple example. The reality is they could be maxing out and with over 50 catch up contributions may be putting $26k ($19.5k + $6.5k) plus any employer contributions. Assuming a 50 year old plans to retire at 62 and maxes out their 401k, that’s 12 years of $26k so another $312k plus any employer contributions. Using the 10% return as the other example, that person would have over $600k additional in their account.

I recently asked our HR to add a Roth component to the employee directed contribution of our 401K. Hopefully it is added to our plan. Fingers crossed!

7

I just spent a few hours crunching a million numbers and learning more about 72(t).

Yeah… I’ll be drawing so much out of all my accounts between maybe 53 and 72 that there will be such a substantial dent by 72 that the RMD won’t even matter, or it will turn out to be a wash.

And yeah… might be able to 72(t) as early as age 53.  If all goes well.  Which, it won’t.  But it would be nice.  :slight_smile:

8

I made a spreadsheet of RMDs where I can input the ROR, SS, Pension, etc. That allowed me to determine how much I need to convert to Roth to avoid going into higher tax brackets when RMD are required. My current plan is to covert as much to Roth as I can while maintaining my current tax bracket. The issue with Roth conversions is they are essentially locked for 5 years after conversion. According to Vanguard their locked if you move Roth from one account (not fund, but account) to another. Since I’m 54 1/2 I took an old 401K which had Roth and rolled it into my accounts so I wouldn’t hit another 5 year clock and would not be locked into the previous employer’s 401K.

One super positive thing from all this is I realized I can cut and run at 59 1/2 without worry. I’m broke until then, but not so much when I hit 60.