If you’re confused about the rules surrounding required minimum distributions from retirement accounts in 2023, the IRS is offering some much-needed clarification – and relief.
A financial advisor can help you plan for RMDs and manage your taxes in retirement. Find a fiduciary advisor today.
When the SECURE 2.0 Act was signed into law in December, the aim was to increase retirement options for workers and encourage more employers to offer retirement plan benefits. But to implement those changes, the IRS needs to write specific rules, which have been causing turmoil when it comes to required minimum distributions (RMDs) from tax-deferred retirement accounts, such as IRAs and 401(k) plans.
The law raises the age at which RMDs begin to 73 for anyone who turns 72 in 2023. (The RMD age will eventually increase to 75 in 2033.) But because many plan sponsors use automated payment systems, some 2023 withdrawals from these retirement accounts were incorrectly characterized as RMDs. This meant that investors weren’t allowed to roll that money over to another account to avoid taxes.
IRS Extends Grace Period for Rollovers, for Some
The IRS had allowed those payments to be considered eligible rollovers if they happened between Jan. 1, 2023 and July 31, 2023. Now, the agency is extending that grace period until the end of September for retirement plan participants and IRA account holders born in 1951.
Why does that matter? The penalty for failing to take an RMD is an excise tax of 25% of the required amount, a hefty penalty compared to the 10% tax taken on other ineligible withdrawals from tax-deferred retirement accounts. But it had been worse: The penalty excise tax was 50% of the required amount prior to SECURE 2.0.
The National Association of Plan Advisers has published a detailed explanation of the changes, while the IRS has published the specific guidance in Notice 2023-54.
Other RMD Considerations
So why do RMDs exist? IRAs, 401(k) accounts, 403(b) accounts and similar workplace retirement plans grow tax-deferred until the investor or their beneficiary starts taking withdrawals. The IRS, however, doesn’t have unlimited patience before it begins collecting those long-delayed taxes, which is why the RMD rules were put in place.
One way to reduce RMDs and avoid the tax hit is to make a contribution to an eligible charity directly from your retirement account using what’s called a qualified charitable distribution. At other times, an account holder might want to start taking withdrawals earlier than the RMD age in order to reduce the account balance if they’re expecting a large windfall in the future. If the sale of a business, property or other taxable asset is going to produce a large capital gain, reducing the size of your retirement account early takes some of that money out of the tax equation before RMDs are required.
You’ll also want to consider whether you’re collecting Social Security benefits and if your RMDs will result in those benefits being taxed. If your adjusted gross income is more than $25,000 for single filers ($32,000 for joint filers) your Social Security payments can be taxable. If an eventual RMD will trigger that tax, an earlier withdrawal from your retirement account may be in order.
Bottom Line
The IRS is extending the grace period for retirement account rollovers for people born in 1951 who received distributions in 2023 that were mistakenly reported as RMDs. As a result, these account holders now have until the end of September to complete their rollovers and further defer taxes on the distributions.
Retirement Planning Tips
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