When retirees prepare for the future, it’s essential to understand how Required Minimum Distributions (RMDs) can affect retirement savings and taxes. RMDs are mandatory withdrawals from specific tax-deferred retirement accounts, and they play a key role in retirement income planning. With the Secure 2.0 Act raising the starting age for RMDs to 73 in 2024, retirees could see larger distributions and higher tax bills. Here’s a breakdown of what these changes mean and how they could impact your retirement strategy moving forward.

Understanding RMDs

RMDs are mandatory yearly withdrawals that retirees are obligated to take from tax-deferred retirement accounts, including 401(k)s, traditional IRAs, and 403(b)s, once they reach a specified age. The purpose of RMDs is to ensure retirees pay taxes on the money they have deferred during their working years. Because these withdrawals require retirees to begin tapping into their retirement savings, RMDs are a key part of managing retirement income and tax obligations.

The Secure 2.0 Act Increased RMD Age to 73

The Secure 2.0 Act, passed in 2022, increased the required minimum distribution (RMD) age from 72 to 73. This gives retirees more time for their retirement savings to grow before mandatory withdrawals begin. The updated rule applies to individuals who turn 73 in 2024 and beyond, allowing for an extra year of tax-deferred growth. (Retirees turning 73 in 2024 must take their first RMD by April 1, 2025.) The delay provides more flexibility, but it can also lead to higher RMDs when withdrawals begin. This is especially true for those who have seen significant returns on their investments over time.

Why 2024 RMDs Could Reach Record Highs

In 2024, several factors—such as tax-deferred growth, the increase in the RMD age to 73, and inflation adjustments—could make RMDs more challenging for retirees. Because retirees must withdraw a set percentage of their account balance, those with well-performing investments could be forced to take out larger sums, resulting in higher taxable income. This may push some retirees into a higher tax bracket, which could reduce their overall retirement income due to the increased tax burden on these withdrawals.

Important Considerations for Retirees Facing RMDs

As you near your RMD age, several critical elements can influence your tax strategy and retirement planning. Understanding these key details will help you make smart financial decisions and avoid costly mistakes when managing your RMDs:

• RMDs Are Subject to Ordinary Income: RMDs are taxed as ordinary income, so the amount you withdraw is added to your other taxable earnings for the year. This can increase your overall tax burden, especially if the RMD raises your total income into a higher tax bracket. This is why strategic tax planning is crucial when managing RMD withdrawals.
• Missing RMD Deadlines Can Lead to Significant Penalties: Failing to withdraw RMDs by the deadline, typically December 31, can trigger steep financial penalties. Currently, the IRS imposes a 25% penalty on the amount not withdrawn. If the oversight is corrected within two years, this penalty may be reduced to 10%. However, missing the deadline remains an expensive error that retirees should aim to avoid with proper planning and timely withdrawals.
• RMDs Are Unavoidable for Tax-Deferred Accounts: Once you reach the age for RMDs, you are legally obligated to withdraw funds from your tax-deferred retirement accounts, regardless of whether you need the money. Skipping these withdrawals can result in steep penalties, and delaying them won’t eliminate the tax obligation. For retirees who don’t need the additional income, reinvesting the RMD into a taxable account can be a strategy to keep the funds growing. However, taxes on the RMD are still required, so planning is essential to manage the tax impact.
• Roth IRAs Exempt from RMD Requirements: To reduce the impact of RMDs, consider holding part of your retirement savings in a Roth IRA. Unlike traditional IRAs or 401(k)s, Roth IRAs are not subject to RMDs during the account owner’s lifetime. Since contributions to Roth IRAs are made with after-tax dollars, both the growth and withdrawals are tax-free, offering greater flexibility in managing retirement income. However, note that inherited Roth IRAs do require beneficiaries to take RMDs, though the withdrawals remain tax-free.