RMDs are something I talked about a lot more in my past life working with retirees. But it’s not something most of my millennial clients have heard of. So, WTF is an RMD?
RMD stands for Required Minimum Distribution. It is the government-mandated amount of money that someone needs to take out of their traditional IRA. Like I said above, older people are far more likely to have experience with them, because RMDs kick into place when the account owner turns age 72. A young person simply doesn’t have to worry about RMDs. Usually.
The exception to the rule is when someone inherits an IRA account. Which is why we’re talking about RMDs on a blog for younger people. It is estimated that $61 trillion is going to be passed down from older generations to the younger in the next 20 years. Since a lot of those funds are likely in traditional IRAs, RMD rules are going to apply to the people inheriting those accounts.
Why are RMDs a thing?
You’ll notice I keep saying that RMDs only apply to traditional IRAs. That’s because money is put into traditional IRAs before taxes. When cash is removed from an IRA is when you pay taxes. Since the US government really wants those taxes, they require a calculated portion of the account to be withdrawn every year after the account owner turns 72 (these rules also apply to other pre-tax accounts, like 401(k)s, but most people roll their 401(k) over to an IRA). Roth accounts pay taxes before they put money in, so the RMD rules aren’t nearly as impactful.
I’m not even close to 72. WTF is an RMD to me?
When a person inherits a traditional IRA or 401(k) from anyone who is not their spouse, they are required to remove all money from the inherited account within 10 years after the original owner’s death. This 10-year rule is actually a new rule; before December 2019, heirs had the rest of their lifetime to stretch the payments out. But, again, the gov wants those taxes.
IRA distributions are considered “earned income” for tax purposes and will count towards how much you “made” for the year. If the IRA you inherit is a big one, this may be a case of mo’ money mo’ problems.
Say you are single and you make $36,000 every year (the annual real median personal income for 2019). If grandma leaves you a $500,000 IRA (I have absolutely seen this happen) and you decide to split your IRA withdrawals evenly across the 10 years, your taxable income will go from $36k to $86k. This will push you from the 12% marginal income tax bracket to the 22% tax bracket AND kick capital gains taxes in from 0% to 15% on any other assets Grandma left you. You’ll also be limited in how much you can deduct from contributions to your own IRA during those 10 years. There’s a lot of shtuff that’s going to get messy.
What can I do?
Unfortunately, there isn’t much you can do to avoid this situation. Talking with your elders (yes, I said elders) about their money might be your best option. It’s an awkward conversation, for sure, but I think you’ll find it to be enlightening to ask about how they want things handled in their memory. Having “The Talk” will also help you be prepared for what you may have to deal with.
You don’t have to spread the withdrawals out evenly over the 10 years. You may be able to finesse some other options. Each person’s situation is different and that’s why it pays to use a professional. Having a conversation with a fee-only financial advisor (*cough* Valkyrie Financial *cough*) and/or an accountant might actually save you money. It’s what good professionals try to do.
But there you go. Now you know WTF is an RMD.