When Should I Pay the Taxes on an RMD?

Required Minimum Distributions (RMDs) are a significant aspect of retirement planning, particularly concerning the timing and payment of taxes. These mandatory withdrawals from tax-deferred retirement accounts require careful consideration to manage their tax implications. Understanding when these distributions become taxable and how to pay taxes on them is essential for navigating retirement finances.

Basics of Required Minimum Distributions

Required Minimum Distributions are annual withdrawals mandated by the government from most tax-deferred retirement accounts. The purpose of RMDs is to ensure that individuals eventually pay taxes on funds that have grown tax-deferred, preventing these accounts from serving as indefinite tax shelters.

RMD rules apply to traditional Individual Retirement Accounts (IRAs), SEP IRAs, SIMPLE IRAs, and employer-sponsored plans like 401(k)s, 403(b)s, and governmental 457(b) plans. Account holders generally must begin taking RMDs once they reach age 73.

Roth IRAs are an exception; the original owner is not required to take RMDs during their lifetime, though beneficiaries are typically subject to RMD rules. While the general age for beginning RMDs is 73, this age is set to increase to 75 by 2033.

When RMDs Become Taxable

Required Minimum Distributions are generally treated as ordinary income and are taxable in the year they are received. This means the distribution amount is added to your other income, potentially affecting your tax bracket.

A specific rule allows for a delay of the first RMD. While the RMD is for the year an individual reaches the designated age, the actual distribution can be postponed until April 1st of the following calendar year.

For instance, if an individual reaches age 73 in 2024, their first RMD is for 2024, but they can delay taking it until April 1, 2025.

Exercising this delay option results in two RMDs being taxed within a single year. The delayed first RMD will be taxed in the same year as the second RMD, which is due by December 31st of that year.

This can substantially increase taxable income for that year, potentially pushing an individual into a higher tax bracket and impacting other income-based calculations, such as those related to Social Security benefits or Medicare premiums.

How to Pay Taxes on RMDs

One common approach is to have taxes withheld directly from the RMD by the financial institution managing the retirement account. While the default federal withholding rate is often 10%, individuals can elect to have more or less withheld, or even no withholding.

Amounts withheld from RMDs are considered to have been paid evenly throughout the year, even if the distribution occurs as a single lump sum late in the year. This can be useful for individuals who prefer to avoid making quarterly estimated tax payments.

By strategically withholding a sufficient amount, they can cover their tax obligations and potentially avoid underpayment penalties.

Alternatively, individuals can pay taxes on their RMDs through estimated tax payments, typically made in quarterly installments. These payments are generally due on April 15, June 15, September 15, and January 15 of the following year.

To avoid underpayment penalties, taxpayers generally need to pay at least 90% of their current year’s tax liability or 100% of their prior year’s tax liability (110% if adjusted gross income exceeded $150,000 in the prior year).

The income from RMDs must be reported on the individual’s annual tax return. Financial institutions typically issue Form 1099-R to report distributions from retirement plans, which helps individuals accurately report their RMD income and calculate their overall tax liability.

Situations Affecting RMD Tax Timing

Qualified Charitable Distributions (QCDs) offer a way to reduce the taxable portion of an RMD. Individuals aged 70½ or older can directly transfer up to $108,000 annually from their IRA to a qualified charity.

This direct transfer counts towards the RMD but is excluded from taxable income, thereby lowering the individual’s adjusted gross income and potentially reducing their overall tax bill.

QCDs must be made directly from the IRA to the charity; if funds are distributed to the individual first, they do not qualify as a QCD.

Qualified Longevity Annuity Contracts (QLACs) provide another avenue to defer RMDs. By investing a portion of a retirement account into a QLAC, individuals can postpone the start of RMDs on that amount until a later age, typically up to age 85.

This defers the tax payment on the deferred portion of the RMD until those annuity payments begin.

For Inherited IRAs, RMD rules differ for beneficiaries, impacting tax timing. For most non-spousal beneficiaries of IRAs inherited after 2019, the entire account balance must be distributed by the end of the 10th year following the original owner’s death.

If the original owner died on or after their RMD beginning date, annual RMDs may also be required in years one through nine of the 10-year period.

Roth conversions can eliminate future RMDs and their associated tax payments from the converted funds. When pre-tax IRA funds are converted to a Roth IRA, the converted amount is immediately subject to income tax.

Once converted, these funds and their earnings can grow tax-free and are not subject to RMDs for the original owner, removing future tax obligations from that portion of retirement savings.

Any RMD for the year must be taken before a Roth conversion can occur.