Tax-deferred (“Traditional”) retirement accounts allow individuals to save for retirement by making contributions while they are working, and deferring taxes on those contributions, along with taxes on any earnings to a later date, usually in retirement. Federal employees have their Traditional TSP through their employer, and many also open Traditional IRAs (Individual Retirement Account) on their own. By deferring taxes, individuals can save for the future and allow their investments to grow tax-free.
However, eventually, the Internal Revenue Service (IRS) will want its cut, requiring individuals to take required minimum distributions (RMDs) from tax-deferred retirement accounts once they reach a certain age. RMDs are the minimum amount that an individual must withdraw from their retirement account each year. Congress recently passed legislation (the SECURE Act) that changed the RMD age. For 2023, individuals who are already, or turning 73 will be subject to RMDs. RMDs are considered taxable income and if an individual does not take their RMD, they may be subject to a further penalty tax. It is important for individuals to understand their RMD exposure and plan accordingly to avoid any penalties or unexpected tax bills.
You determine your RMD by looking at the balance of your Traditional retirement account (TSP, IRA, 401k etc) at the end of the year. You then take that balance and divide it by the associated distribution period from the IRS’s “Uniform Lifetime Table” (ULT) and are essentially based on life expectancy.² Below is an example of the most commonly used ULT
What’s always been strange to us at PARCO is that the concept of RMDs is made complicated by the layout of the table. A much simpler way to think about your RMD exposure is to know what percentage of your balance you need to take out. To determine this, we just take the 1/Distribution Period. So for a 75 year old, the RMD required is 1/24.6 or 4.065%.³
Let’s use a real example with a 75 year old USPS retiree named Paul who has a Traditional IRA balance of $100,000. Using the RMD table, Paul would determine that his applicable distribution period is 24.6. We take his Traditional balance at the end of 2022 of $100,000 and divide it by this amount to get his RMD of $4,065.04. Alternatively using the method above, we could have multiplied his balance by 4.065% to arrive at the same amount.
Timing is an important factor to consider when taking required minimum distributions (RMDs) from tax-deferred retirement accounts. One of the main considerations when deciding when to take an RMD is market volatility. If an individual takes an RMD when the market is down, they may be forced to sell investments at a loss in order to meet the RMD requirement. On the other hand, if the market is performing well, the individual may be able to sell their investments at a profit, potentially offsetting some of the tax burden.
There’s a lot to strategize when it comes to RMDs, however one ultimate strategy is to avoid them altogether using a Roth IRA and Roth Conversion. It’s something we’ve talked about at length in past webinars (click on the button below to visit our Webinar Gallery), but the key point is that by converting money from your traditional accounts into a Roth IRA, especially before you reach your RMD age, you can significantly reduce if not eliminate your RMD exposure since Roth IRAs are not subject to RMDs. Importantly, you cannot do Roth conversions within the TSP itself. To learn more about how to strategize for RMD’s book a time with one of our experts here.
¹RMD age increases to 73 in 2023 under secure 2.0. 401k Specialist . (n.d.). Retrieved January 5, 2023, from https://401kspecialistmag.com/rmd-age-increases-to-73-in-2023-under-secure-2-0/
²Retirement topics - required minimum distributions (rmds). Internal Revenue Service. (n.d.). Retrieved January 5, 2023, from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds
³Ben Geier, C. E. P. F. (2022, December 30). Ira required minimum distributions table 2023. SmartAsset. Retrieved January 5, 2023, from https://smartasset.com/retirement/rmd-table
⁴Butler, P., & Avery, D. (2022, December 30). Here's when you'll have to start paying your student loans again. CNET. Retrieved January 5, 2023, from https://www.cnet.com/personal-finance/loans/student-loan-debt-heres-when-youll-have-to-start-making-payments-again/