Whether you’re preparing for retirement or already enjoying it, one thing remains true: You want to make the most of your income and protect it from unnecessary penalties. Sounds easier said than done, especially when required minimum distribution (RMD) rules change from time to time and both RMDs and withdrawal strategies have tax consequences. We’re here to help simplify important details:
- Understanding how RMDs work.
- Learning how 2021 rules differ from 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act exemptions.
- Inheriting an IRA―and the applicable tax implications.
- Avoiding tax penalties.
- Planning ahead for RMDs in your pre-RMD years.
What’s an RMD?
RMDs are required minimum distributions investors must take every year from their retirement savings accounts, including traditional IRAs, and employer-sponsored plans such as 401(k)s, and Roth 401(k)s, starting at age 72.
- If you’re turning 72 this year and taking your first RMD, you have until April 1, 2022, to do so. For each subsequent year, your RMD must be taken by December 31. Keep in mind, if you delay your initial RMD until April 1, you’ll be responsible for 2 withdrawals that year (one by April 1 and one by December 31), which could result in a larger tax liability.
- If you’re older than 72, you must take your RMD by December 31 each year.
Note: Roth IRAs aren’t subject to RMDs.
Set a reminder to avoid the penalty
It’s very important to withdraw your RMD on an annual basis. If you forget, you’ll face a 50% penalty tax on any amount not withdrawn.
What’s the difference between 2020 and 2021 RMD requirements?
Last year, the RMD age increased from 70½ to 72 as a result of the Setting Every Community Up for Security Enhancement (SECURE) Act, and RMDs were waived by the CARES Act. The temporary waiver applied to:
- 2020 RMDs from traditional IRAs, inherited IRAs, and employer-sponsored plans.
- 2019 RMDs due by April 1, 2020, for individuals who turned 70½ in 2019 and didn’t take their RMDs before January 1, 2020.
There is no longer an RMD waiver for 2021. As a result, anyone age 72 or older as of December 31, 2021, must take their RMD by year-end to avoid the 50% penalty―unless this is their first RMD, in which case they have until April 1, 2022.
What are the RMD rules for inherited IRAs?
If you inherited an IRA, including a Roth IRA, you must take RMDs from the account. You won’t owe taxes on withdrawals from an inherited Roth IRA as long as the original owner held the account for at least 5 years. But you’ll owe taxes on withdrawals from an inherited traditional IRA.
The rules for how IRA beneficiaries must take RMDs depend on when the original account owner passed away and the type of beneficiary. For example:
- Generally, nonspouse beneficiaries that inherit an IRA from someone that passed away in 2020 or later may be required to withdraw the entire account balance within 10 years.
- Spousal beneficiaries and certain eligible nonspouse beneficiaries may be permitted to take RMDs over their life expectancy.
Check out our inherited RMD calculation methods for more information.
What if I don’t need the RMD assets?
RMDs are designed to spread out your retirement savings and related taxes over your lifetime. If you don’t depend on the money to satisfy your spending needs, you may want to consider:
- Reinvesting your distributions in a taxable account to take advantage of continued growth. You can then add beneficiaries to that account without passing along future RMDs to them.
- Gifting up to $100,000 annually to a qualified charity. Generally, qualified charitable distributions, or QCDs, aren’t subject to ordinary federal income taxes. As a result, they’re excluded from your taxable income.
How can I be sure to avoid the 50% penalty tax?
Depending on the amount you’re required to take, the cost of missing an RMD can be pretty significant. To avoid a penalty, take the full amount each year. Otherwise, you’ll owe the IRS 50% of the shortfall.
Penalty for missing the entire distribution or a portion of it
|RMD amount||Amount distributed||Amount not distributed (subject to the 50% penalty)||50% IRS penalty tax|
Does Vanguard offer a service that can help with my RMD calculations and distributions?
Once you reach RMD age, we’ll automatically calculate your annual distribution amount for any traditional IRAs and Individual 401(k)s held at Vanguard. You’ll receive an annual statement in late January and can also find your calculation here. You can also enroll in our free and convenient RMD Service, which allows you to set up your RMDs to be automatically distributed each year. It’s a great way to make sure you never miss a distribution or find yourself subject to the 50% penalty.
It’s easy to enroll in automatic distributions
Simply set up one annual lump-sum distribution or spread your RMD throughout the year.
How are RMDs calculated?
Calculating RMD amounts can get a bit complicated, which is why we recommend leaving it to the experts. But here’s a high-level overview of how it works.
RMD amounts are determined by looking at the following factors:
- Your age as of December 31 of the current year and your corresponding life expectancy factor according to the IRS Uniform Lifetime Table or Joint Life and Last Survivor Table if your spouse is your sole beneficiary and more than 10 years younger than you.
- Your retirement account balance as of December 31 of the previous year, which should be adjusted to include any outstanding rollovers or asset transfers that weren’t in the account at year-end. Note: In this situation, you’ll need to call Vanguard to confirm the value of the outstanding rollover assets that need to be included in your December 31 balance.
For example, let’s say you’ll be age 75 as of December 31, 2021, and your life expectancy factor is 22.9. If the value of your IRA as of December 31, 2020, is $800,000, your RMD would be $34,934.50 ($800,000/22.9).
New life expectancy calculations coming
A new IRS table will be used in 2022 with a larger life expectancy factor per age, which will result in smaller RMD amounts. This is good news because you’ll still have the flexibility to withdraw more if you need to, but you can also reap the benefit of having a larger account balance with the potential for continued growth.
What are some tax tips pre-RMD retirees should consider?
When you’re over 59½ and in your pre-RMD years, you have the flexibility to annually revisit how to minimize your taxes―both now and in the future. For example, if you have a large balance in a tax-deferred account, like a traditional IRA or 401(k), and could face high RMDs in the future, you may benefit from:
- Withdrawing those assets in the years leading up to age 72. While you’ll be accelerating some tax liability up front, you’ll be lowering future RMDs through a smaller account balance.
- Converting some of your traditional IRA assets to a Roth IRA, which isn’t subject to RMDs or taxes when you withdraw your assets in retirement (provided you’ve held the account for at least 5 years). Learn more about the benefits of a Roth conversion to see if it might be a smart move for you.
“Taxes matter, so work with a tax or financial professional. This is key because withdrawal strategies, including Social Security timing decisions, have tax consequences beyond RMDs,” said Maria Bruno, head of Vanguard U.S. Wealth Planning Research, in a recent article.
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Vanguard advisors can help you feel confident about your financial future―creating a spending strategy to help maximize your retirement income in a tax-efficient way.
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We recommend that you consult a tax or financial advisor about your individual situation.
Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.
The services provided to clients who elect to receive ongoing advice will vary based upon the amount of assets in a portfolio. Please review the Form CRS and Vanguard Personal Advisor Services Brochure for important details about the service, including its asset-based service levels and fee breakpoints."RMDs are back for 2021: What you need to know",