Take advantage of shifting RMD rules with these year-end strategies

Ahead of the year-end deadline for retirement-account holders aged 73 or older to take their required minimum distributions or pay a hefty tax penalty, many are waiting until the last minute.

As of late last month, about 20% of RMD-eligible holders of individual retirement accounts with Fidelity Investments had not withdrawn any amount toward fulfilling their 2023 obligation, and another 31% had extracted only a portion, according to figures released last week by the giant brokerage, custodian and asset management firm. The data highlighted the importance of a perennial topic of conversation around this time of year with clients, as well as the shifting rules under the Secure 2.0 Act for current holders and those inheriting retirement accounts.

"These numbers are typical for what we see among our client base, but December is quite busy in seeing a large portion of RMDs since some people prefer waiting to see what market conditions are like before taking their distribution," Rita Assaf, the vice president of retirement products at Fidelity, said in an email. She noted that, because Secure 2.0 pushed back the age by one year to 73 in 2023, this year marks the only one without any first-time RMDs.

READ MORE: 7 tax-planning provisions in SECURE 2.0

"Often people are surprised to find out that RMDs count toward income, which means it can push individuals into higher tax brackets and impact Social Security and Medicare," she said. "We suggest people work with a financial advisor or tax professional to help them understand and optimize the RMD process, since every situation is unique. Beyond tax implications, I would also encourage people to think about how RMDs fit into their long-term plan. What I mean by that is, you might want to consider how you plan to use your RMD distribution — you might need it for day-to-day expenses or spend it on something bigger. For example, you may want to remodel your home, take a trip or even give it where you can gift it to family or a charity.  Alternatively, you can reinvest the money in a non-retirement account as well."

In addition to the specific guidance on RMDs from the IRS, Fidelity's website includes a calculator providing an estimate using the agency's formula. It and other companies also give planners and their clients the ability to set up automatic withdrawals, which is a step favored by financial advisor Sarin Barsoumian of Burlington, Massachusetts-based SMB Financial Strategies. The percentage of Fidelity clients who had yet to take their RMD as of Nov. 28 "blows my mind," she said in an email.

"This distribution can be automated to ensure that distributions are taken annually and to avoid tax penalties," Barsoumian said.

The 2022 Secure 2.0 law tacked on further changes to RMDs from IRAs, simplified employee pension (SEP) accounts, simple IRAs, 401(k)s and 403(b) accounts after its predecessor, the 2019 Secure Act, had first altered the rules. The initial law extended the RMD age to 72 from 70½, while the last one kicked them further back another year and to 75 in 2033. Besides that adjustment, the second law slashed the penalty for not taking an RMD to 25% of the amount the client was supposed to withdraw from 50%.

READ MORE: 30 tax questions to answer by the end of the year

Secure 2.0 gave more flexibility for those running afoul of the RMD provisions by reducing the tax hit to just 10% if the retirement savers do take the withdrawal in a timely manner and file a corrected return within two years, according to Jacob DuBose, a Denver-based principal wealth manager with Savvy Advisors. All of the variation offers advisors another way to display their value to clients who may not be caught up on the new statutes, he said in an interview.

"People are confused about what the rules really are now. It's moved a couple of times in the last few years," DuBose said. "A lot has changed for a lot of people's finances over the past few years."

The client's age, account balance, life expectancy and cash-flow needs each play a role in deciding on the particular amount of an RMD, said Danielle Darling, an advisor with St. Albans, Missouri-based Resource One Advisors.

"I educate clients about the required minimum distribution the second I know they have a retirement account," Darling said in an email. "Educating clients early and often helps prevent potential penalties and empowers clients to stay on top of understanding how their retirement accounts work along with the account obligations."

READ MORE: How higher 401(k) and IRA limits may change financial plans next year

Conversion to Roth accounts, which have no RMDs, or potential qualified charitable contributions represent a couple of paths available to planners and clients seeking to avoid getting bumped up into a higher income tax bracket, she noted.

The second Secure Act boosted the amount that clients may kick over on a tax-free basis from a retirement account to a qualified longevity annuity contract to $200,000 per person, which cuts the level of RMD and defers the income until the customer is up to 85 years old, DuBose pointed out.

"It does add another option to the way that you're planning for this," he said. "Let's get deeper into your plan holistically. You now have more tools in your toolbox to throw at it."

Those inheriting IRAs or other retirement accounts got their second one-year reprieve from RMDs in a row from the IRS in July, as beneficiaries adjust to another provision of the first Secure Act that sped up the timeline for the mandatory withdrawals, Assaf said.

"The new rules require most non-spouse beneficiaries to take RMDs over a 10-year period if the decedent was taking RMDs when they died," she said. "What this means is RMDs are required years 1-9 and, in year 10, all funds would need to be withdrawn from the account. Distributions during the 10-year window would be based on the beneficiary's own single life expectancy. There are some people who will be exempt from the 10-year rule — this is, again, where it's best to work with a financial professional or a tax advisor for your personal situation."