Required Minimum Distribution

What is a Required Minimum Distribution?

A Required Minimum Distribution (RMD) is a mandatory withdrawal that owners of certain tax-deferred retirement accounts must begin taking once they reach a specific age. Enforced by the IRS, RMDs ensure that taxes are eventually paid on the deferred income and gains accumulated within these accounts. The Secure Act 2.0, enacted in late 2022, raised the RMD age from 72 to 73 for individuals who turn 73 after December 31, 2022. For those turning 74 after 2032, the RMD age will further increase to 75. This rule applies to traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, 403(b)s, 457(b)s, and other defined contribution plans. Roth IRAs, however, are exempt from RMDs for the original owner.

How RMDs Work for Real Estate Investors

For real estate investors, understanding RMDs is crucial because these withdrawals are added to their taxable income, which can include rental income, capital gains from property sales, and other investment earnings. This additional income can push investors into higher tax brackets, affecting their overall financial planning and investment strategies. While real estate itself isn't typically held directly within these traditional retirement accounts due to complexities, the cash generated from other investments in these accounts must still be withdrawn according to RMD rules.

Key Accounts Subject to RMDs

• Traditional IRAs: The most common type of account subject to RMDs.
• SEP IRAs and SIMPLE IRAs: Retirement plans for small businesses and self-employed individuals.
• 401(k)s, 403(b)s, and 457(b)s: Employer-sponsored retirement plans. Note that if you are still working for the employer sponsoring the plan, you may be able to delay RMDs from that specific plan until you retire, provided you are not a 5% owner.

Age and Timing

Your first RMD must be taken by April 1 of the year following the year you reach the RMD age (your 'RMD beginning date'). For all subsequent years, RMDs must be taken by December 31. If you delay your first RMD until April 1 of the following year, you will have to take two RMDs in that year: your first RMD by April 1, and your second RMD by December 31. This can significantly increase your taxable income for that year.

Calculating Your Required Minimum Distribution

The calculation of your RMD is based on your account balance at the end of the previous year and your life expectancy, as determined by IRS Uniform Lifetime Tables. If your spouse is more than 10 years younger than you and is the sole beneficiary of your account, you might use the Joint Life and Last Survivor Expectancy Table, which generally results in smaller RMDs.

Step-by-Step Calculation Process

1. Determine Account Balance: Find the fair market value of your retirement account(s) as of December 31 of the previous year. If you have multiple IRAs, you must calculate the RMD for each, but you can withdraw the total RMD from any one or combination of your IRA accounts. For 401(k)s, RMDs must be taken from each separate 401(k) account.
2. Find Your Life Expectancy Factor: Consult the IRS Uniform Lifetime Table (or the Joint Life and Last Survivor Expectancy Table if applicable) for your age. This table provides a divisor based on your age.
3. Calculate the RMD: Divide your account balance (from Step 1) by the life expectancy factor (from Step 2). The result is your Required Minimum Distribution for the current year.

Real-World Example: RMD Calculation

Let's consider an investor, Sarah, who turned 73 in 2023. Her traditional IRA balance on December 31, 2022, was $500,000. According to the IRS Uniform Lifetime Table for someone aged 73, the life expectancy factor is 26.5.

• Account Balance (Dec 31, 2022): $500,000
• Sarah's Age in 2023: 73
• Life Expectancy Factor (for age 73): 26.5
• RMD Calculation: $500,000 / 26.5 = $18,867.92

Sarah must withdraw at least $18,867.92 from her IRA by December 31, 2023 (or by April 1, 2024, for her first RMD, but then a second RMD would be due by December 31, 2024). This amount will be added to her other income and taxed at her ordinary income tax rate.

Tax Implications and Penalties

Tax Treatment of RMDs

RMDs are generally taxed as ordinary income in the year they are received. This means they are subject to federal income tax and potentially state income tax, depending on your state of residence. For real estate investors, this can be particularly impactful. If an investor has significant rental income from their properties, the additional RMD income could push them into a higher tax bracket, increasing their overall tax burden. It's essential to factor RMDs into your annual tax planning to avoid surprises.

Penalties for Non-Compliance

The IRS imposes a substantial penalty for failing to take a full RMD or for taking it late. The penalty is typically 25% of the amount not withdrawn. However, under Secure Act 2.0, this penalty can be reduced to 10% if the RMD is taken and the penalty is corrected within a specified period. This makes it critical for investors to meticulously track their RMD obligations and ensure timely withdrawals.

Strategies for Managing RMDs with Real Estate

Real estate investors often seek ways to mitigate the tax impact of RMDs. Here are a couple of strategies:

Qualified Charitable Distributions (QCDs)

If you are charitably inclined and at least 70½ years old, you can make a Qualified Charitable Distribution (QCD) directly from your IRA to an eligible charity. A QCD counts towards your RMD for the year, up to $105,000 (indexed for inflation), and is excluded from your taxable income. This is a powerful strategy for reducing taxable income while fulfilling philanthropic goals, especially for investors with substantial RMDs.

Roth Conversions

While Roth IRAs are not subject to RMDs for the original owner, converting funds from a traditional IRA to a Roth IRA can be a proactive strategy. You pay taxes on the converted amount in the year of conversion, but future qualified withdrawals from the Roth IRA, including those that would have been RMDs, are tax-free. This strategy is best considered before RMDs begin, allowing you to manage the tax hit of conversion over several years, potentially during periods of lower income or before significant real estate gains.