How Are Required Minimum Distributions (RMDs) Taxed? + Video

One of the most common milestones in retirement comes when you reach the age at which you must begin taking Required Minimum Distributions, or RMDs. These withdrawals apply to most tax-deferred retirement accounts and they often raise the same question: how are RMDs taxed?

The short answer is that RMDs are generally taxed as ordinary income. But like many things in retirement planning, the details can bring nuance. Let’s take a closer look at how RMDs work, how they’re taxed, and what you can do to minimize their impact on your financial plan.

https://www.youtube.com/watch?v=KuD0rsWJmfI

What Exactly is an RMD?

An RMD is the minimum amount you’re required to withdraw each year from your tax-deferred retirement accounts once you reach a certain age. The purpose is simple: the IRS gave you tax breaks on those contributions when you were working, and now it wants to start collecting taxes.

For most retirees today, RMDs must begin at age 73. That age will increase to 75 in 2033 under current law. The amount you must take each year is based on your account balance at the end of the prior year and your life expectancy as calculated by IRS tables.

Which Accounts are Affected?

Not all accounts are subject to RMDs. Here’s a breakdown:

• Traditional IRAs: Yes, RMDs are required.
• 401(k)s and 403(b)s: Yes, unless you’re still working for the employer sponsoring the plan.
• SEP IRAs and SIMPLE IRAs: Yes, they have RMDs too.
• Roth IRAs: No, you don’t have to take RMDs during your lifetime. (This is one reason Roth IRAs are such a powerful planning tool.)
• Roth 401(k)s: No

How are RMDs Taxed?

When you withdraw your RMD, the amount is added to your taxable income for the year. It’s then taxed at your marginal income tax rate. That means it’s treated the same way as wages, pensions, or withdrawals from other traditional retirement accounts.

Like any other withdrawal from a retirement account, RMDs are not subject to capital gains tax. Because the contributions were tax-deferred, everything that comes out, including the growth, is taxed as ordinary income.

An Example

Suppose you turn 73 this year and your traditional IRA had a balance of $1,000,000 on December 31 of last year. The IRS Uniform Lifetime Table shows that someone age 73 has a life expectancy factor of 26.5 years.

Divide $1,000,000 by 26.5, and your first RMD is roughly $37,736. That means you must withdraw at least that amount this year.

If you’re in the 22% federal income tax bracket, the withdrawal could generate about $8,301 in federal taxes. (State income taxes may apply as well, though not in Texas.)

What if You Don’t Take an RMD?

The IRS imposes a stiff penalty if you fail to take your full RMD. The penalty used to be 50% of the amount you should have withdrawn, but recent law changes have reduced it. Now, the penalty is 25%, and it can drop to 10% if you correct the mistake quickly.

Still, the penalty is steep enough that you don’t want to miss an RMD. Staying organized and setting reminders can help prevent costly mistakes.

The Ripple Effects of RMDs

The tax on your RMD isn’t the only thing to consider. Adding RMD income to your tax return can trigger other consequences:

• Social Security taxation: As we discussed in the previous article, more of your Social Security benefits may become taxable if your RMD raises your provisional income.
• Medicare surcharges: Higher income can also increase your Medicare Part B and Part D premiums through what’s called IRMAA (Income-Related Monthly Adjustment Amount).
• Tax bracket creep: A large RMD could push you into a higher marginal tax bracket, especially if you have other sources of income.

These ripple effects are why RMD planning is about more than just the withdrawal itself.

Strategies to Manage RMD Taxes

While you can’t avoid RMDs altogether (at least not from traditional accounts), there are strategies to reduce the tax impact:

• Roth conversions: Moving money from a traditional IRA into a Roth IRA before RMD age can lower the balance that’s subject to RMDs later. Yes, you’ll pay taxes on the conversion, but it may be at a lower rate and on your terms.
• Qualified Charitable Distributions (QCDs): If you’re at least 70½, you can transfer up to $108,000 directly from your IRA to a qualified charity. This counts toward your RMD but you don’t include it in your taxable income.
• Delay retirement account withdrawals until they’re more favorable: For some retirees, it makes sense to live off other assets for a while before RMD age, then take distributions when required. For others, taking controlled withdrawals earlier (before RMDs kick in) can smooth out income over time. This is why it’s important to plan withdrawals with tax-efficiency in mind.
• Coordinate with other income sources: Balancing withdrawals with Social Security, pensions, and other income can help you manage your overall tax exposure. It can also help you avoid other issues with your withdrawal strategy and help ensure that your savings lasts as long as you need it to.

Planning for RMDs

RMDs are one of the few truly “required” parts of retirement. You don’t get to choose whether you take them, but you do get to choose how you plan for them. By understanding how RMDs are calculated, how they’re taxed, and how they interact with the rest of your financial plan, you can avoid surprises and create a retirement income strategy that makes the most of your savings.

With proper planning, RMDs don’t have to be a burden. Instead, they can be just one piece of a well-designed income plan that balances today’s spending with tomorrow’s security.

Belonging Wealth Management is a fee-only fiduciary financial planning firm serving Longview, TX and surrounding East Texas towns. We help retirees and pre-retirees create tax-efficient retirement income plans, investment strategies, and long-term financial plans tailored to their goals. If you want a personalized retirement strategy built around your goals, email us at brandon@belongingwealth.com or call 903-471-0624 and we’d be glad to help you.