Understanding Required Minimum Distributions

The idea behind Required Minimum Distributions, or RMDs, is that the government wants to give us a tax incentive to save for retirement, but they also want to make sure we don’t misuse it. For example, if we’re in the 24% tax bracket and we put money into a tax-deductible IRA or a 401(k), each dollar we put in only costs us 76 cents because it’s a before-tax contribution. So, the government is helping us save, but the government also really wants this to be retirement money. In other words, they don’t want it to be money that you never spend or leave for your heirs. Most importantly they want to make sure you pay tax on it eventually.

IRAs are one example of a use-specific plan, which the government loves. The 529 College Tuition Plan is another example. It’s extremely tax-efficient for the investor if used for college, but extremely tax-inefficient if used for retirement. Similarly, IRAs are designed to encourage people to save money for retirement, and if the money is used for that purpose, then it’s taxed in a friendly manner. If it’s used for anything else, it’s not.

The Longevity Challenge
The challenge for the IRS in providing this incentive for retirement savings has been the same challenge faced by the Social Security Administration in maintaining the system’s solvency: people are living longer. Today, there is a 50% chance that the average 65-year-old American will live into their late 80s. The average couple aged 65 has a 50% chance that at least one spouse will live to age 92. The IRS doesn’t want to wait until your death to get its tax money because it might end up waiting a very long time. Thus, everyone is required to begin taking minimum distributions from their savings plans after age 73.

To the government’s credit, it has lowered RMD percentage amounts in recent years because it recognized that increasing longevity rates were creating challenges from the other end as well, with some people legitimately worried about depleting their IRAs before they died. The bottom line is simply that the IRS doesn’t want retirement income vehicles to be used as inheritance vehicles, so they require you to take minimum amounts of income from those vehicles each year
once you’ve reached the required age.

When Do I Take RMDs?
The SECURE Act 2.0 was signed into law on December 29, 2022. The age when RMDs need to begin increases from age 72 to age 73 in 2023 and age 75 in 2033. The one exception to this is for someone still employed at age 73 at a business that they do not own. In that case, you do not have to take Required Minimum Distributions on that particular retirement plan. You still must take them on any other retirement plans, such as your IRA, but not on the plan that’s with a company for which you are still employed at age 73.