Brace Yourself for Higher RMDs in 2024

Key Takeaways

• Money can’t stay in an IRA or 401(k) forever. Your required beginning date, or RBD, is when you have to start taking the funds out and paying the tax. Thanks to Secure 2.0, the age for required minimum distributions is now 73, but it was 72.
• You may have a larger RMD compared with the size of your IRA balance, but it’s the right amount because it’s based on last year’s ending balance. You can’t change that amount.
• Converting to Roth is a strategy for potentially reducing future RMDs. Roth conversions always cost more once you’re into RMDs. That doesn’t mean you can’t convert once you’re into RMDs, say after age 73, but it costs more.

Christine Benz: Hi, I am Christine Benz for Morningstar. Tax and IRA expert Ed Slott says that people who are subject to required minimum distributions may be in for a nasty tax surprise this year. He’s here with me to discuss that topic. Ed, thank you so much for being here.

Ed Slott: Thanks, Christine.

Required Minimum Distributions

Benz: Ed, let’s start by talking about these required minimum distributions. First, who’s subject to them? Because this has been changing a little bit over the past few years. And also what accounts do they pertain to?

Slott: All right. RMDs, required minimum distributions, money can’t stay in an IRA or 401(k) forever. That was the deal you made, the deal with the devil, you got tax deductions all those years, but as any deal with the devil, there’s a day of reckoning, and that’s called your required beginning date when you have to start taking the funds out and paying the tax, and that’s your required beginning date, RBD. RBD also stands for a really big deal because it’s so complicated now and a lot of the rules surround themselves around whether you passed your RBD or not. So let’s start with a simple version, people that have an IRA or 401(k). Thanks to Secure 2.0, the age for required minimum distributions is now 73, but it was 72, so some people were confused. Which age applies to me? I think most of that is washed out now by 2024.

If you’re 73 this year, you have an RMD due this year on your IRA, and also in your 401(k), but there’s another little twist. If you’re still working at your company, there may be a way to delay it. If your company, which most do, has what’s called a still-working option, you can delay RMDs from your 401(k) until you retire, even if that’s at 90 years old. So you could delay it. I don’t know if that’s such a good idea because remember, thanks to the original Secure Act, which some young people told me ... I was doing a program recently, I was talking about the difference between the original Secure Act and Secure 2.0. They said, “Why don’t you call the original Secure Act the OG?”

Benz: I’ve heard that.

Slott: Right? All right, so the OG, original gangster or whatever—I don’t know what it has to do with the Secure Act. But the original Secure Act killed the stretch IRA, that long deferral for beneficiaries where they used to be able to go out 50, 60, 70 years. Now you have a 10-year rule after death. So, the longer you delay RMDs, more income is going to be pushed in for the rest of your life and 10 years thereafter. And when you push more income into a shorter window, taxes are going to get hit. You’ll get hit with generally higher taxes, and it may be even higher rates by then. The RBD, the age is 73. The required beginning date is April 1 of the year after, only for your first RMD. If you turned 73 this year, your first RMD is due by April 1, 2025. So in 2024, if you turn 73, you use age 73. Your first RMD is due April 1, 2025.

The confusion there is, that’s the only time you’ll use April 1. Every year after that, the RMD is due by Dec. 31, the end of the year. But if you wait till—and this rule has been around forever—but if you wait till next year, say April 1, to take your first RMD for 2024, you have to take two RMDs that year because the second one is due by the end of ‘25. A better option for most people is take your first RMD, if this is your year, you’re 73, your first RMD, this year. So you only have to take one next year, separating the income of your first two RMDs into two separate tax years, usually a lower tax in each case.

So that’s the main point on the RMDs. If you’re already into RMDs, then don’t worry about April 1. Let’s say you’re 75, you’ve been taking RMDs, you just keep taking them and they’re always based on the year-end balance. And that brings us to the year-end balance at Dec. 31, 2023, which I believe, and you can correct me on this, was the highest year-end balance in history, if you’re going by the stock market.

Benz: Right, the market is hitting new highs all the time.

Slott: But those highs don’t count. The only day that counts for RMDs is the balance on Dec. 31, 2023. Last year’s ending balance will determine this year’s RMDs, and that was, I believe, an all-time high as far as a year-end balance.

Larger-Than-Expected RMDs in 2024

Benz: So, people are contending with, maybe, larger-than-expected RMDs.

Slott: Yes.

Benz: Can you talk about that dimension of it?

Slott: Yes, nobody likes, as they look at their tax return, “Wait a minute, my RMD was so much less last year. How could this be?” Well, it’s based on last year. But let’s say, I hope not, but let’s say by the time they take their RMD this year, the market crashes and It’s way down, it’s still based on last year’s ending balance. So, you may have a larger RMD compared to the size of your IRA balance, but it’s the right amount because it’s based on last year’s ending balance. That number is locked in. That amount is already in the books. You can’t change that amount, has to be taken, let’s say, each year. If it’s your first one, like I said, it’s the April 1 date, or if it’s the recurring ones, by the end of the year. So, most people will see larger RMDs. Not the end of the world, it means more money is coming out, and we have lower tax rates.

Nobody likes paying tax on RMDs. But really if you look at the long-term big picture, as I said, with the 10-year rule on the back end, you may want to spread it out. In some cases, you may even want to take more than the RMD if you look at your taxes over your life and the life of your beneficiaries of that 10-year spread, so that it doesn’t all get bunched into a shorter window. But you will have higher RMDs based on last year’s balances, and you better check your estimated taxes with your accountant to make sure you have the right amount of tax paid in.

One way to do that, if you don’t need the money from the RMD, and a lot of people don’t, believe it or not. Nobody likes taking RMDs. They only take them, at least the clients that I’ve dealt with over the years, they only take them because they have to. They have other monies, the last thing they want is to take money, forced to be taking money out and pay tax. So, they take the minimum amount. I’m saying maybe take even a little more this year because long term it may save you more in taxes, taking advantage of historically low tax rates. We still have low tax rates for this year and next year. We don’t know what’s going to be after 2025 when the Tax Cuts and Jobs Act, those tax cuts expire.

You may want to look big picture, but one of the things you can do, I started talking about if you don’t need the money, you were just going to take the RMD and put it in another account, then take federal withholding tax out of that. This way you don’t have an estimated tax problem because withholding is treated as being paid in evenly throughout the year, which is good because most people seem to take their RMDs toward the end of the year. Very few people take that earlier in the year. So, if you took your RMD, say in December, well, you could have an estimated tax problem if you didn’t have enough estimated tax paid in, but if you did the withholding at that point, and it was enough to cover the tax, and you could even do it to cover tax on other investments that are not withheld.

I’ve had clients where we used to do a 100% withholding, and they never had to worry about estimated taxes. I had that with this one client years ago, had it with a few of them, but this one guy, this is years ago, and he had all these investments, and he was declining. He was old. He had large RMDs, over $100,000 a year. So, when I did the taxes, I prepared the four vouchers, sent it to them, and then come next year, “Oh, I didn’t pay anything, I forgot.” So, finally, I said, “This isn’t going to work. You’re getting penalties every year for underpayment. Because you don’t pay. That’s why I send you the vouchers.” I sent him the vouchers with the envelope, even can put stamps on, everything. Didn’t get paid. I spoke to the guy’s son who was an attorney in New York, and I said, “Can you do this for your dad? Just, he’s not paying in a thing.” “Oh, I’ll take care of it.” P.S.: He didn’t take care of it either.

So then, had the same problem. So, then I said to them, “Look, I’m going to take a 100% withholding from your RMD. You don’t need the money anyway, and it will cover all the taxes you will owe on your other investments and income.” And that’s what we did, and they loved it. Why? Because they thought they weren’t paying taxes anymore. There were no estimated taxes. It came right out. They just didn’t get their RMD, but it went to the government. No estimated tax penalties, no underpayment penalties, and it worked beautifully. I’m not saying that’s a system for everybody, but if you take federal withholding, it’s treated under the tax code. Even if you withhold Dec. 31—I would never wait that long—but Dec. 31, it’s still treated under the tax code, just as wage withholding as being withheld evenly throughout the year.

Benz: That’s helpful, Ed, and you mentioned that many people do, in fact, wait until later in the year to take their RMDs. Can you just underscore that there’s no benefit, there’s no way to change your tax bill. It’s cooked based on whatever your balance was at the end of 2023, right?

Slott: Right. It’s locked in. The amount is locked in, but some people wait till the end.

Benz: OK.

Slott: There’s no benefit, but there is one benefit. I usually tell people to hold off, in case, if you’re subject to RMDs, that means you’re over age 70 and a half, and you also qualify for qualified charitable distributions. And if you want those to offset your RMD, those have to be done first. So, it’s better to do the RMDs later in the year when you may not even have to do them. But let’s say your RMD is $10,000, and you haven’t done it yet, and you want to give $10,000 to charity, and you do the QCD, a direct transfer from the IRA to the charity, then you don’t even have an RMD due. But if you did it in the opposite order, you would. If you took the RMD first, once it’s before the QCD, it can’t be offset.

Tax Implications of Required Minimum Distributions

Benz: I want to delve into the tax implications of RMDs a little bit, Ed. There’s the ordinary income tax that’s due, but there can also be these knock-on tax effects that seem to really bug people, like social security taxation, like IRMAA. Maybe you can talk about some of those.

Slott: All I can say is, be prepared for it because these funds have to come out anyway, not if, but when. So, it’s going to hit. Almost everybody now of even a decent livable income, is subject to the 85% tax on social security because those levels have never been adjusted for inflation. They’re so low, so concede on that. You’re just going to pay the income tax on 85% of your benefits because it’s such a low threshold. But there’s IRMAA, Medicare Income-Related Monthly Adjustment Amount, that’s not on the tax return, but they have tiers, different tiers, and if you go $1 over, it’s a cliff and that could make your premiums for Parts B and D go higher. But again, all of these things are going to happen anyway.

Let’s say you try and lower the RMDs, you just take the minimum. At some point, more will have to come out, and this is going to happen anyway. Maybe you just want to take the big hit in one year, eventually it’s going to happen. Another surprise tax is the 3.8% tax on net investment income. Those thresholds have also never been raised for inflation, so more people are subject to that. Things like medical expenses. So many things are tied to your adjusted gross income, and RMDs increase adjusted gross income. One thing you can do to lower that is, like I said, the QCD. It takes the RMD income, if you do it in the order I said, it takes it off the tax return.

Can Converting to a Roth Reduce Future RMDs?

Benz: I want to follow up on that. Relatedly, one thing that RMD-subject investors often think about is, well, what if I convert some of these assets, these traditional IRA assets that are subject to RMDs, what if I convert them to Roth as a strategy for potentially mitigating future RMDs or reducing future RMDs? Can you talk about that?

Slott: Yes, I recommend that all the time, most effective before you start RMDs. Roth conversion always costs more once you’re into RMDs. Doesn’t mean you can’t convert once you’re into RMD, say after age 73, but it costs more. Here’s why, the RMD cannot be converted. If you are in an RMD territory, you have to take the RMD. You must take it, and you pay tax on it, and it cannot be converted. Once you satisfy that year’s RMD, then any part or all of the remaining IRA balance can be converted, but it costs more because you had to pay the tax on the RMD, which couldn’t be converted. The best time is usually like in your 60s, Do a series of maybe smaller annual conversions over time. In a perfect world, you get rid of your whole IRA before 73, then you have no RMDs, and you have a tax-free Roth.

Also for the Medicare IRMAA charges, if you want to mitigate that, do the Roth conversions before turning, not 65—that’s a mistake people make because they say, “Well, that’s where Medicare starts.” No, there’s a two-year lookback, before age 63. For example, extreme again, let’s say you converted everything to your Roth IRA by age 62. Well, then you’ll have no RMDs from your IRA, and at least the RMDs will not trigger the Medicare charges. The point here is to manage the RMDs to your tax benefit, however they come out, but the money will come out, at the latest, through your beneficiaries at 10 years after death. So, the longer you spread them out, for most people, unless your income goes up and down substantially, you’re going to have less tax over time.

Benz: Ed, always great to get your insights. Such an important topic. Thank you so much for being here.

Slott: Thanks, Christine.

Benz: Thanks for watching. I’m Christine Benz for Morningstar.

Watch How to Use a Backdoor Roth IRA for more from Christine Benz.