Required Minimum Distributions--What's all the fuss about?
As the IRS so succinctly puts it, “You cannot keep retirement funds in your account indefinitely.”
I would add, “Nor should you want to.”
There is a lot of ink spilled in financial articles about these vile, dreaded Required Minimum Distributions (RMDs). People have sheepishly confessed to me about their distributions in hushed tones generally reserved more for a conversation about STDs, instead of RMDs. People—it’s not that bad. Really. Relax. Avoiding RMDs at all cost is the same logic that would cause you to turn down a raise at work because you might have to pay taxes on it. Or ripping up the winning Powerball ticket because, well, you would just “hate to give the government that much money in taxes.”
I’m not saying I like paying taxes. After all, I’m a CPA. It’s against our religion. When we are awarded our badges, and taught the secret handshake, we swear a blood oath to (legally) avoid as many taxes as possible. And to defer the ones we can’t avoid. But the fact remains that, in this country, generally the more money you earn, the more taxes you pay on that money. (Until at least we wise up, adopt the policies of the great Dr. Art Laffer, and go with a flat tax.) In essence, paying taxes is the negative by-product of being monetarily successful. And until the government raises the tax brackets to over 50%, I’m still always getting more money than the government is, even after taxes.
But I’m getting ahead of myself.
What exactly are Required Minimum Distributions?
With most (but not all) retirement savings accounts, like the Thrift Savings Plan, at age 72, you are required to start withdrawing some money from the total balance. The IRS tells you how much you have to withdraw, which we’ll get to in a minute. For now, just understand, once you hit 72 years of age, Uncle Sam makes you start taking your money. Why would he care? Because he wants his cut!
With regards to the TSP, this RMD rule applies to both sides of the TSP—Traditional or Roth. Prior to age 72, you don’t HAVE to do anything with your TSP money. Let’s say you’re a DEA agent that retired at age 46. You are not required to do anything with your TSP for 26 years. You could pull some out before age 72, and most people do, but just understand you aren’t required to.
But wait a second, Chris. I’ve already paid taxes on my Roth TSP. When I pull that money out, it’s not taxed. So why does the government force me to withdraw at 72 from my Roth TSP? Good question.
Exactly how much am I required to withdraw?
Well that depends on your age. We’ve already mentioned you have to begin taking some withdrawals at age 72 (read on for some exceptions to this rule), but understand that you have to take a certain percentage of your account based on your age. And it changes each year. Essentially, the IRS is making you withdraw money by using your life expectancy.
In the real world, there are several life expectancy tables that can be used for retirement accounts. In the TSP world, only the “Uniform Lifetime Table” is used. Regardless if you are single, married, and regardless of how old your beneficiaries are, you still use the Uniform Lifetime Table for the TSP. Not so with private IRAs.
(CAVEAT: If you inherited a TSP, you will use the “Single Life Table” after the first year. See TSP-776, “Tax Information about TSP Withdrawals for RMD for Beneficiary Participants”.)
Luckily for us, the TSP prints this chart on page 4 of TSP publication TSP-775. It’s fairly simple to use:
Find the number next to your age on the chart
Know your overall TSP balance
Divide #2 by #1
Let’s do some examples:
Say you are 76 years old. On the chart, the number next to 76 is 22.0. Let’s also say you have $1 million in your TSP. We’d take $1,000,000 divide by 22.0. That would give us $45,454.55. That would be the RMD for that year.
Let’s say you are 96 years old and have $1m in TSP. That would be $1m/8.1 = $123,456.79. As you can see, the older you get, the larger percentage you have to withdraw from your TSP.
Live to be 116, and you have to withdraw $526,315.79 that year on a $1m balance.
There are some calculators online that can run these numbers for you. Here is one from Fidelity. Be careful. Use them as a guide, but not as the final answer.
IMPORTANT NOTE: See further down—these tables will change 1/1/2022
Exactly when do I have to start this?
IMPORTANT NOTE: SECURE ACT 2.0 ALTERED RMD AGES. FOR EXAMPLE, IT RAISES THE RMD AGE TO 75 FOR THOSE BORN AFTER 1960.
Those are the broad strokes of how it works. Let’s dig into the details a little more. Be careful here—we start to get into the minutiae.
The First Distribution Calendar Year. You have to take your first distribution by April 1st of the year following when you turned 72. Let’s say you turn 72 on January 19, 2022. You would need to take your first RMD by April 1 of 2023.
Subsequent Years. After this first distribution, all other distributions have to be made by 12/31 each year. If you’re astute, you will have noticed that you may have TWO separate withdrawals in one tax year.
Example:
John turns 72 on January 19, 2022. He is not required to take his RMD until April 1, 2023. John takes his RMD in March of 2023, prior to the deadline. He’s good. But now he has to also take his annual 2023 RMD by 12/31/23. This would mean 2 RMD withdrawals in the same year. John may not be happy with that for tax reasons. If he’s trying to reduce his income for the year, he certainly didn’t do it in this example.
So is there a way John can avoid two payouts in one year? Yep.
Example:
Even though John is not REQUIRED to take his initial RMD until April 1st of the year after he turns 72, he doesn’t HAVE to wait that long. Remember John turned 72 on 1/19/22. If he wants, John can take his first year RMD in 2022. That will satisfy the IRS. Then, he would only be left with the RMD for 2023, which is due by 12/31/23.
Still Working. If you have not retired from the employer that controls your retirement plan—so the federal government for you TSPers—you do NOT have to take an RMD until you retire. More on that in just a second. But for now, let’s do one more example. Let’s say you are 73 and now decide to retire. Whatever calendar year you retire in, the RMD will be due the next April.
Example:
John is 73. He retires on 12/31/21. His first RMD is due April 1st of 2022. Why? Because 1.) he already attained the age of 72, and 2.) RMD’s are due the first April after the calendar year you retire. He retired in 2021, even if he retired on the very last day of the calendar year. He still retired in 2021.
In this example, John would HAVE to take two RMD’s in the same year. Since he would not be able to take his April 2022 RMD in 2021—he just wasn’t retired long enough to get it done. He was technically only retired about 7 hours in 2021. (COB to Midnight).
You say, Chris, this doesn’t seem fair! Well, John could work a few days into 2022 and then retire. Or he can just realize the IRS won on this one. Or John could have retired years ago and started whittling down the balance for tax purposes.
Exactly what balance is the RMD figured on?
The balance in your TSP as of 12/31 of the year previous. Let’s say you turn 73 in 2021. By 12/31/21, you have to take an RMD that would be your total TSP balance as of 12/31/20 divided by 24.7 (the number next to age 73 in the Uniform Lifetime Table).
Is there any way around this?
Well….kinda. If you are still working for the government, you will not have to take RMDs from your TSP. RMDs only apply if you meet two criteria: 1.) Be separated from the government and 2.) Be 72 or older (see above). If you’re 85, and still moving papers from the in box to the out box for Uncle Sam, you don’t have to worry about RMDs. (Which is a good thing, because you probably have a lot of other things to worry about!)
Roth IRAs don’t have RMDs. Please note, I said Roth IRAs. The Roth TSP DOES have RMDs. So if you don’t want RMDs from your Roth TSP, you could transfer that balance to a Roth IRA, and forget all about the RMDs from that account in your lifetime.
Keep in mind, though, that withdrawals from Roths are not taxable, even if they are RMDs from the TSP. Remember—you already paid taxes on those contributions before you made them.
To be clear, Traditional IRAs, 401ks, SEPs, SIMPLE IRAs, and TSPs (Both Trad and Roth) DO have RMDs.
What if I refuse to play the government’s game?
A bold strategy, indeed, Cotton. If you do not withdraw the appropriate amount, our benevolent and merciful Uncle Sam will simply charge you a very modest 50% tax on what you should have withdrawn. Blew off your $50,000 RMD? The government will charge you $25,000 in “excise” tax for that indiscretion. Hey, you didn’t think federal grant studies into the yellow-throated wood newt’s migration pattern funded itself, did you?
Here’s some good news: This extra tax won’t really be an issue with TSP holders. TSP will do the calculation each year and if you haven’t satisfied your required withdrawals by December, they’ll automatically send it to you in time. Or they are supposed to. It would be something I’d stay on top of, if I were you, just in case.
For example, TSP just sent out their end of the year schedule this past week. For 2021, any RMDs from beneficiary participant accounts (inherited TSPs), will be automatically processed on December 17th. Any RMDs still needed to be distributed from regular TSP accounts (both civilian and military) will be processed on December 20th. In other words, if you don’t take enough out-either intentionally or unintentionally, the TSP’s got you covered. They’ll just send you a check to keep you in the good graces of the Internal Revenue Service.
For your IRAs, you probably will be on your own. So, be prepared to do some math. Or write a check to your favorite accountant, and thank God for CPAs when you say your prayers at night.
What exactly counts toward my withdrawals?
For you TSP holders, your installment payments AND any single withdrawal payments count toward the required minimum each year. If you’re already pulling enough monthly so that the total is more than the RMD, you’re fine. If you’re not pulling quite enough each month, then you may have to increase your monthly amount, or you may have to take a single withdrawal to make up the rest of the required minimum.
“I’ve got a way around this—I’ll just have my RMD amounts automatically transferred to a different IRA. That way, I avoid the withdrawals that year!”
Sorry, not allowed. And I think you’re missing the point—Uncle Sam wants his money. If he can make you increase your income, he gets a part of it. That’s the point of all of this.
This seems so complicated, Chris, is there anything that can make it even more complicated?
Oh yes!—There’s always more Internal Revenue Code gems to mine. Remember how I said the TSP only uses the Uniform Lifetime Table to determine RMDs? Your IRAs and other accounts won’t automatically use this. Depending on if you are married or single, and how much younger your beneficiary is, or who the beneficiary is, you may need to use Table I (Single Life Expectancy) or Table II (Joint Life and Last Survivor Expectancy). Or you may get to stick with the Uniform Lifetime Table. You need to know which one to use.
But since this is primarily geared toward FERSonians, we’ll just stick with what they need— the Uniform Lifetime Table.
Ok, now that we know what RMDs are, and how they work, why is everything I’ve read about them discussed in a negative way?
At the heart of this issue is the fact that RMDs can raise your income. Your taxable income. Which means, by default, you’re paying more taxes. It could also mean that not only are you paying more taxes, but you’re also paying a higher tax rate on some of the money (if the income pushes you into a higher tax bracket). This can have a series of cascading effects. It could cause your Medicare Part B payments to go up. It can mean your capital gains tax on the sale of an asset (stocks, home, etc.) may be at a higher rate. It could mean that more of your Social Security income is taxed. So there are certainly some potential consequences. (Reminder: Roth TSP withdrawals are NOT taxed).
It also means that the money that was in the account is no longer in there to continue growing and making you money. This is only partly true. Yes, the money comes out of the account, but once you get the money, you can put it back into a mutual fund or brokerage account. Like at Schwab or Fidelity. In other words, just because the money comes out of the TSP doesn’t mean it just disappears, or is required to be spent on that bass boat. (Or at Tory Burch, if you’re Mrs. Barfield Financial.)
For those reasons, you’ll see a lot of articles written that have strategies to lessen your TSP balance over time, rather than waiting until RMD age, where you may have to withdraw more than you really want to.
Is it something I stress out over? No, not particularly. I’m not concerned about RMDs that much, personally. I saved my money for decades so that I can use it. I’m not saving it simply to pass it along. And I don’t want to leave it all in there until I’m really ready to live it up in my 80’s! That seems like a less-than-optimal plan.
The fact that it gets taxed when I pull it out was my understanding when I chose to go with the Traditional TSP all those years ago. Rather than the Roth TSP.
But, Chris—what if you’re put into the 32% tax bracket? Or even the 35% bracket!? Just to be clear here, I’d LOVE to be in the 37% bracket!! That would mean I’m making over $600k a year! Would I rather have $600k a year taxed at 37%, or $80k a year taxed at 12%? That’s a pretty easy decision for me.
As I said at the outset, I’m not a fan of paying taxes, but I am a fan of making a lot of money. And taxes are the biproduct of making money. I will reduce the taxes where I can, and how I can, but I’m not going to refuse to use what I’ve sacrificed for decades to build just because the government will also get a piece of it. In my mind, if I take that approach, what was the point of saving all those years? I should have just lived it up when I made it.
I will lessen the government’s chunk any way I can—except for refusing to take my chunk.
Having said that, I know financially smart people that are terrified of RMDs. They don’t want to get at their money, even into their 70’s. They wish there were no such thing as RMDs. I would assume that some of them plan on leaving the money to their heirs. And there are probably other reasons they have as well. And I’m sure they are perfectly valid.
So to each their own. I’m not here to tell you exactly what to do. I’ve always seen my role as that of an educator, more than an advisor. I show you how the system and rules work, and you decide how you want to apply them to your individual situation. If you’ve sat through any of my retirement seminars, you’ve definitely heard, “Personal finance is very personal.” In other words, the only financial situation that matters is YOURS, not what some cat in the Wall Street Journal says.
If you’ve decided you want to enact strategies to help lessen the effects of RMDs, here are a few you might want to consider:
Go with a Roth TSP and then when you separate from the government, transfer the balance to a Roth IRA. No RMDs in your lifetime.
Once you separate from the government, start withdrawing some of that Traditional TSP balance immediately, rather than waiting until 72. Let’s say you retire at 57. That’s about 15 years you have to spread withdrawals out to reduce your account balance. By taking a little bit each year, it could be better for your taxes. For you SCE’s retiring at 50, you could have 22 years of lessening your TSP balance. You need to plan this out with a CPA.
The financial articles have done a tremendous job instilling fear in everyone that they will run out of money. “Wait until 72 to withdraw your money! Wait until 70 to file for Social Security! Or you’ll be destitute!” I don’t subscribe to this school of thought in the least. I will write another article in more depth on this, but I find that most people are far too conservative in their withdrawal strategies. Talk to retirees that have been withdrawing money for years. You might find the same thing. Here is a TSP calculator that might help with planning withdrawals. And, show you how your balance may continue to grow, even when taking withdrawals.
Consider saving in accounts not subject to RMDs. We’ve talked about Roth already, but maybe consider saving/investing in taxable brokerage accounts. Not tax deductible, and you’ll pay capital gains and probably dividend income, but you won’t ever be FORCED to withdraw a certain amount. This is at the heart of the multiple bucket strategy of savings.
Roth Conversions. Beyond the scope of this article, but if you want to get that Traditional TSP balance money out from under the RMD rules, perhaps transferring it to a Traditional IRA and then doing small amounts of Roth conversions each year in retirement might be a strategy. You DEFINITELY need to speak to a CPA about this. You’ll need to know how far you are from your next tax bracket.
That first year, make sure you take your first RMD early. So you don’t have two distributions in one tax year.
Discuss your plans with a financial pro to come up with even more strategies that work for you.
Lastly, you could just keep working forever. If you shuffle off this mortal coil while still an active FERSonian, you successfully avoided RMD’s in your lifetime. Take THAT, Mr. IRS! This seems like the worst strategy to me, but hey, you do you.
VERY IMPORTANT 2022 UPDATE
Effective 1/1/22, the Uniform Lifetime Table (as well as the others) will be updated. I am sure that TSP will subsequently update their publications. But the new TSP booklet is not available right now. So, if RMD’s affect you in 2022, please make sure you are using the correct table.
For example, in TSP-775 (10/2020), the dividing factor for age 72 is 25.6. In 2022, according to the updated IRS table, the dividing factor will be 27.4. This will mean a smaller RMD if you know how math works. The larger the divider, the smaller the resulting RMD. Take a look:
$1m / 25.6 = $38,461
$1m / 27.4 = $36,496
So if you’re subject to RMDs, you’ll have to pull out less than you would have in years past. My man, Kitces, has a good comparison on this HERE.
What about AFTER my lifetime?
Well, we’ll have to leave that for another day. This entire article is about RMDs for you, during your lifetime. Rules for Inherited IRAs, TSP Beneficiary Participant Accounts, etc., have specific rules for what the heir is required (or allowed to do). Stay tuned for that discussion in the future….
Summary
You don’t HAVE to do anything with your TSP after you retire, at least until age 72, 73, 0r now 75.
At age 72-75, you HAVE to start withdrawing the minimum amount per IRS rules, assuming you are retired
Make sure you use the updated Uniform Lifetime Table for your year of RMD-It changes in 2022
There are a few strategies that can help minimize the amounts you must take
You are highly encouraged to talk to a CPA for planning purposes