Episode 75 – RMDs explained: what to expect when you turn 73
If you have a DCP or Plan 3 investment account, you’re required by the IRS to withdraw a minimum distribution (RMD) from your pretax balance when you reach age 73. We take a look at how the amount you’re required to withdraw is calculated. We also look at special cases like inherited accounts and exceptions for those still working.
Episode transcript:
[music intro]
Jenny
Welcome back to Fund Your Future with DRS. So, if you have a DCP or Plan 3 investment account, there’s an IRS requirement that you have to take called required minimum distributions from your pretax balance, when you separate from service, retire and then finally reach that age of 73. And because these accounts grow tax free, it’s basically the government’s way of saying that they want to start collecting taxes from your accounts and a very small percentage of way. So, we’re digging into these required minimum distributions.
Seth
Yeah. So, lots of questions at the end of the year about taxes and required minimum distributions. And we know especially the first time you have to take an RMD, you can get a little bit confusing. The IRS has also changed the age over the last few years. When required minimum distributions start. So that can add some confusion to the conversation as well.
But generally speaking, when you start taking an RMD, it’ll be about 4% of your account balance, a little less than 4% to start off with. And then as you get older, that percentage gets bigger and bigger and bigger. You have to start taking out a larger chunk of your balance. But the thing to remember, as you just said, Jenny, your account can still be growing, it’s still invested.
And so, your RMD amount will change based on the percentage you have to take out, but also what the account balance was the previous year. And depending on if the market did well or poorly, that’s also going to impact the amount of your RMD.
Jenny
Yeah, so kind of the basics. And do folks have to do anything to receive this money or to start their RMD?
Seth
It’s a good question. So first our record keepers, currently Voya Financial, will always send out a notice once you’re eligible for an RMD and letting you know, hey, this is what your calculated amount for your minimum distribution will be this year. And if you don’t do anything at the end of the year, in October or November, depending on, what you’re invested in, you will be forced out that distribution. So even if you forget, you will receive that distribution.
The way to think about it, though, is you yourself can take distributions throughout the year. So, if you have a required a minimum distribution that’s calculated, say at $10,000 at the start of the year, maybe you took out $5,000 in July because you went on vacation. Then come the end of the year, the record keeper will do that calculation.
Say you still have another $5,000 left to meet your required minimum distribution for the year, and so that’ll be force out to you. The nice thing is, once you’ve taken a distribution out of your Plan 3 or your DCP account, the record keeper will have your bank account information and so they can directly deposit it into your bank.
Whereas if you haven’t done that, they’ll be sending you a check. Then you have to figure out, you know, I guess cashing checks is easier for people now. You just take a photo of it or whatever and gets it deposited. But back in the 1900s, in the olden days, you used to have to walk that check over or drive that check over to your financial institution.
Jenny
Yeah. And we just want to remind folks, too, that these RMDs just apply to when we’re looking at DCP funds, it really just applies to that pretax money. If you have all of your money in your Roth DCP, maybe if you transferred it over or deposited, you would not have to take an RMD.
Seth
Yeah, because we are really just talking about pretax accounts. And it is important to remember that RMDs also apply to other pretax accounts. So if you have a 401 K or a 403 B, each one of those will have a balance. So, the RMD will be calculated on the balance from the previous year, the end of the previous year.
So, you have to take a distribution from each one of those accounts to meet the minimum distribution. It’s another reason why some people consolidate accounts. They roll over their accounts all into one account, into an IRA or into DCP. They roll all of their accounts so that way they only have to calculate one RMD. They know what the amount is going to be and they don’t forget about an account.
And as you said, most places will force out those accounts to you. But sometimes people, also have an account they inherited from their spouse who passed away or from a parent. And those accounts can have RMDs associated with them. And oftentimes the age when you have to start taking that distribution is based on the original account holder, not you.
And so, if I’m 68 years old, but my spouse is deceased and they were 75 and had already starting taking RMDs, I’m going to have to start taking RMDs on that account, even though I’m not 73 yet. And so that’s an important thing.
One of my parents inherited an RMD from one of their siblings, with an investment account, and they inherited the RMD as well. And so, they weren’t they weren’t 73 yet. They were a little bit confused about, oh, I’m starting to get this money. And then they knew, okay, every year I’m going to get this balance. I’m going to have to figure out what I’m going to do with this, this income. That’s make sure I’m reporting on my taxes, make sure that I have had had enough withheld from it.
Jenny
Yeah. And then also we just wanted to remind folks that this obviously doesn’t apply to pensions as well. So, this is just strictly investment accounts and strictly the Plan 3 investment accounts as we talked about with those Plan 3s have two accounts. But this really only just applies to those pretax investment accounts.
Seth
Yeah. So, the RMD amount is based on that investment balance. And so, your pension account doesn’t… Once you start collecting your pension there’s not an investment balance associated with the part that is paying your pension. Whether you’re a Plan 2 member or Plan 3 member. It’s very frequent, especially in the year a person turns their RMD age to contact DRS and say, “hey, I’m receiving this monthly pension. Do I also need to take an RMD?” And they don’t have to worry about that. There’s no required minimum distribution associated with the pension part of your retirement with the state.
One thing I think that is helpful for people to do, especially as they approach RMD age, is just do a rough calculation of what that dollar amount is going to be. Because a lot of times people can get really good at saving and they’re not really good at spending.
And so just the unexpected income that comes from an RMD. So, if you’ve done really great in saving and you end up with $1 million in your investment account, your first RMD payment is going to be around $40,000. And for some people, that’s like as much as they’re receiving in their pension, like their paycheck just doubled.
And that can be exciting. But it can also be scary because then you owe more in taxes. You have a higher income. You’re going to owe more in taxes. And as you said earlier, Jenny, the reason RMDs are a thing is because the IRS wants their money like you’ve had the opportunity to save pretax. This whole time, but at some point, you’re going to have to start taking that as income and have a reportable income for your taxes.
So do a calculation. Look at what your total investment accounts are, not just in Plan 3 and DCP, but if you have a 401(k) or an IRA, think about what your total RMD is going to be, and then think about what you’re going to do with that. Do you need to set aside, you know 10% will be withheld for taxes, but maybe you need to have more because it’s going to push you up into a higher tax bracket and figure out what your plan for that money is.
Do you have something you need to spend it on, or are you going to put it back in savings in a different savings environment, in an after tax savings vehicle, in a bank account, in a CD? What sort of things might you do with that money?
Jenny
[You could] donate the money. You know, you can do all kinds of things with it.
Seth
Well, there’s you can’t do this out of your Plan 3 or your DCP account, but there is a way to do a charitable RMD, a charitable minimum distribution where you’re basically giving the money to a charity and they don’t have to pay taxes if there are a certain, type of charity and you don’t have to pay taxes because it’s like making a charitable contribution out of your investment account.
We are not tax advisors. We don’t know exactly how that interacts. But I know it’s a question we get sometimes and you’re in you’re not able to do it out of a 457 account. It’s sometimes a reason people will roll money out of their investment accounts with the state, because they want to make charitable distributions out of that account.
Jenny
Oh, that’s a great thing to consider. So Seth, you mentioned that, if people want to have a general idea of how this is calculated, it’s about 4%. But what are the specifics on how these RMDs are calculated?
Seth
Yeah. So, there’s a whole table on the IRS page: Uniform Lifetime Table. And the way it works is you plug in what your age is and then it’ll provide you a divisor, an expected life expectancy going forward. And so, it starts off with numbers around 25. And that’s where you get the 4% general RMD calculation. But then that divisor gets smaller and smaller, which means the distributions you’re going to have to take is going to get bigger and bigger each year.
And so, once a person gets into like their late 80s or 90s, they’re starting to take almost 10% of their account balance as an RMD. And once again, hopefully the account is continuing to grow. It’s still invested. So, the amount they’re receiving is going to be different, but it’s a way to help ensure they are exhausting that account over time.
And that they’re going to have to pay the taxes on those distributions. So generally starts off, you know, you’re going to receive around 4% per year. And then as you age, that percentage is going to increase. So, 5%, 6%, you know, up to 10 or 12% as you age. I don’t have the table in front of me. I think like once you get to 100, you’re taking really large portions of that account balance each year as a minimum distribution.
Jenny
And then what about for folks that are still employed because we kind of said, you have to take these RMDs once you’ve separated from service, what if you’re 73 and you’re still working? Hopefully you’re not. But if you are, what about for those folks?
Seth
Yeah, you do not have to take an RMD out of your account, if you’re still working. And for some people, they’re still actively contributing to their DCP. They want to put more money away. Maybe they started saving late. And so they’re working a few extra years to make sure they have, significant income or money saved.
So, yeah, if you’re actively working, you do not have to start taking your RMD yet. And that is also another common question. When they realize they’ve reached RMD age, they start to look for all the different accounts they have and make sure that they’re going to take distributions out of them. So yeah, if you’re actively working you do not have to take a distribution.
Jenny
Okay. I guess again with the timeline. So, say I’m 72 this year and I’m going to be turning 73 in May. When could I kind of expect to start seeing some of that information from Voya about my accounts? Yeah.
Seth
So usually in the spring there’s going to be some initial letter letting you know what your RMD amount has been calculated at.
Jenny
Gotcha. So even if I’m, I don’t turn 73 until December 15th of that year, I would get something in the spring. Yeah.
Seth
It’s going to be the year you turn 73. Yeah, yeah. And then your RMD distribution will be forced out in October or November depending on what you’re invested in. And then a good reminder you file those taxes the following year. So, in spring of the next year. So, in 2025, you take your first required minimum distribution near the end of the year.
And then in February, early February, you’ll receive a tax form, 1099 R form from the record keeper. And that’s what you’ll use when you file your taxes to show what the income was, to show how much was withheld in taxes as part of your overall tax filing. And one thing we also hear from folks is especially as they go through retirement, their different income streams start at different times.
So, they might have started their pension at 65. They start Social Security at 67. Then their RMDs kick in at 73. And frequently they end up having to change their tax withholdings on one of those different income streams. Or maybe all of them. They find out, “oh, I haven’t had enough withheld.” And you can always change your tax withholdings going forward.
And I don’t think anybody expects to get it right the first time. Or you shouldn’t expect to get it right the first time, because there are going to be different things that are that are changing within your income. And then, tax tables in tax brackets are going to change over time as well.
So, you know, really good time, especially the first time you take an RMD good time to talk to a tax professional. Make sure that you’re withholding the proper amounts. Or if there’s maybe a way to be more, optimized in your tax withholding.
Jenny
Excellent. Well, any final thoughts?
Seth
No, I think RMDs can be scary, especially the first time. And really, I think sometimes people can get frustrated by how much they’re having to pay in taxes. And really, it’s a reward for you being a great saver. And I think that’s the thing. Like, these are good problems to have. If you’ve saved enough to notice that you’re having a big RMD, that’s a that’s a great thing to think about.
And then, think about what other things you might do with those funds. If you’re worried about having a safety net, making sure that you’re saving those money in some other way after you’ve taken the distribution.
Jenny
For sure. And of course, talk to your financial advisor.
Seth
Yeah, yeah, talk to folks. Talk to tax advisors, talk to estate planners. You know, there’s all sorts of different moving pieces with retirement savings and tax taxes, especially. Perfect. Great. Thanks, Jenny.
Jenny
Thank you!
[music outro]
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