IRS rules dictate that you can’t just let your money sit in your retirement accounts indefinitely without eventually withdrawing that money when you retire. The IRS says that you must begin taking required minimum distributions (RMDs) from accounts by a certain age if you’ve received certain tax breaks. You’ll pay a steep penalty otherwise.Knowing how to satisfy RMD rules can help you choose the right account for your financial needs in retirement.
RMD Factors That Are Unique to Roth IRAs
Roth accounts have some of the same tax benefits as traditional IRAs, but they differ in some crucial respects. You’re putting post-tax money into your Roth IRA account. You can’t deduct the money from your taxable income or claim a tax credit for it, but the earnings will grow tax free. You paid tax on the money before you put it in the account, so you pay no tax on it when you take it out in retirement. The IRS therefore has no reason to require that you withdraw it. Roth IRAs don’t require RMDs during the account owner’s lifetime. This exception from RMD rules for Roth IRAs may not affect you if you intend to start taking from your Roth IRA before the RMD starting age. For those who may not need to withdraw funds from their Roth IRA when they retire, a Roth IRA provides a great chance to allow your earnings to keep growing tax free. You may even be able to pass the money to your heirs.
Inherited Roth IRA RMDs
Although Roth IRA account owners don’t have to take RMDs, you’ll have to take RMDs if you inherit a Roth according to the same rules that govern RMDs for traditional IRAs. You would have to take out your RMDs as though the account owner had died before their required RMD start date. If you’re a spouse beneficiary, you can:
Treat the Roth IRA as your own. You’ll have to name yourself as the account owner if you want to choose this option.Figure out and take your RMDs based on Table I. You don’t have to start taking money out until the owner would have reached their RMD starting age.
As a non-spouse beneficiary, you can:
Withdraw the full balance by the tenth year following the owner’s death, although exceptions exist for minor children.Figure out and take your RMDs based on Table I.
RMDs Apply to Traditional IRAs, Too
Owners of certain retirement plans, including 401(k) plans, traditional IRAs, SIMPLE IRAs, and SEP IRAs, used to be required to begin to withdraw money when they reached age 70½. But anyone who reached age 70½ on or after Jan. 1, 2020, has until age 72 to begin taking money out of their accounts. RMDs are the least amount that you must withdraw from your account every year, and these amounts are included in your taxable income. Tax-deductible accounts such as traditional IRAs allow you to deduct the money you contribute from your taxable income so you can defer paying taxes on that money until you retire, RMDs give the IRS the chance to collect tax on money that was tax free up until this point. Any portion of a withdrawal that was taxed at the time of contribution should be treated as tax free. For example, Roth money that’s rolled into a 401(k) account wouldn’t be counted as taxable income because you initially contributed that money with after-tax dollars. You may find that you have to withdraw more than the required minimum amount to make ends meet in retirement. This is fine because, as the name suggests, RMDs are simply the least amount you have to take out. You can certainly take more. But this rule will trigger income taxes for retirees who have other sources of income or who may not need to spend the money in these types of accounts after the RMD starting age. A portion of the funds will no longer be in the IRA account after you start taking RMDs, so the chance for future tax-deferred growth on those funds is lost. A few web-based RMD calculators, such as Schwab’s RMD calculator, can also help you figure out your IRA RMDs.
The Bottom Line
Both traditional and Roth IRAs provide tax breaks. Roth IRAs give retired people the flexibility to spend their account assets when they want to. People must begin taking money out of their traditional IRAs when they get to the RMD age. Tax-free growth ceases in a traditional IRA when RMDs begin. You may want to put money into a Roth IRA along with or instead of a traditional IRA if you expect to have other income sources when you stop working. Roth IRAs have an edge in this case because they allow you to keep growing your account assets tax free or even pass your wealth on to your heirs.
