Week 15 Day 6: RMDs: The Government Wants Its Money Eventually

The government gave you a tax break when you contributed to a 401(k). Eventually, they want the taxes. Starting at age 73 (75 for those born in 1960 or later), you must withdraw a minimum amount each year based on your age and balance. Fail to withdraw, and the penalty is 25% of the amount you should have taken.

RMDs are calculated by dividing your account balance by a life expectancy factor from IRS tables. At 73, the factor is approximately 26.5, meaning you must withdraw about 3.8% of your balance. At 80, the factor drops to about 20.2, meaning roughly 5% withdrawal. At 90, about 8.6%. The RMDs increase as a percentage each year, which can push you into higher tax brackets and trigger additional taxes on Social Security benefits or higher Medicare premiums (IRMAA surcharges). Strategies to manage RMDs: (1) Roth conversions before RMD age -- every dollar converted to Roth never has RMDs. (2) Qualified Charitable Distributions (QCDs) -- after age 70.5, you can donate up to $105,000/year directly from your IRA to charity, satisfying your RMD without increasing taxable income. (3) Strategic spending from Traditional accounts in early retirement to reduce the balance before RMDs begin. Roth IRAs have no RMDs for the original owner -- another major advantage.

The SECURE Act of 2019 pushed the RMD start age from 70.5 to 72, and SECURE 2.0 (2022) further pushed it to 73 (effective 2023) and will push to 75 in 2033. The RMD penalty was reduced from 50% to 25% (and 10% if corrected promptly) by SECURE 2.0. These changes extend the Roth conversion planning window by several years. For a married couple with $2,000,000 in Traditional IRAs, failing to do Roth conversions before age 75 could result in RMDs starting at approximately $76,000/year and escalating to $150,000+ by age 85. Combined with Social Security income, this could push their marginal rate to 22-24% or higher, plus potentially trigger the 85% Social Security taxation threshold and IRMAA surcharges (+$230-740/month per person on Medicare premiums). A well-timed Roth conversion strategy during the retirement 'gap years' (between last paycheck and RMD commencement) can reduce lifetime taxes by $200,000-500,000 for a typical affluent retiree. This is one of the highest-value activities in retirement planning.