Rethinking RMDs: The Key to Smarter Retirement Planning

Retirement is a milestone many eagerly anticipate—a time for relaxation, pursuing hobbies, and cherishing family moments. But when it comes to managing retirement accounts, a surprising majority of retirees may be missing an opportunity with their Required Minimum Distributions (RMDs), according to a recent study.

What is this commonly missed opportunity?  Let’s first dive into the world of RMDs overall to learn more about what they are, why they matter, and considerations for 2025.

What Are RMDs, and Why Do They Matter?

First, let’s understand the basics. RMD stands for Required Minimum Distribution, which is the amount the IRS mandates you withdraw annually from tax-advantaged retirement accounts once you reach a certain age. This applies to accounts like 401(k)s, 403(b)s, 457(b)s, Traditional IRAs, and others. The key exceptions are Roth IRAs and Roth 401ks, as contributions to these accounts are made with post-tax dollars, meaning no taxes are due upon withdrawal.

The logic behind RMDs is simple: The IRS has allowed your investments to grow tax-deferred for years, and at some point, they want their cut of the taxes. Failing to take your RMD on time can lead to penalties as steep as 25% of the amount you were supposed to withdraw, though timely corrections can reduce this penalty to 10%.

The Secure 2.0 Act has recently updated the rules, pushing the RMD age to 73 in 2024 and eventually to 75 by 2033. These changes provide a longer runway for retirees to strategize, but they also require careful planning to avoid pitfalls.

A Potential Missed Opportunity: Taking Only the Minimum

According to a recent study by JP Morgan, 84% of retirees are only withdrawing the minimum required amount from their retirement accounts. At first glance, this seems to make sense—it minimizes taxes in the short term and allows the account to keep growing. However, this approach may lead to unintended consequences, such as:

1. Ballooning Account Balances:
   Over time, accounts left to grow with minimal withdrawals can snowball. For example, a $500,000 account at age 75 could grow to $800,000 or more by age 85, leading to significantly higher RMDs and tax burdens later.
2. Tax Bracket Surprises:
   Larger RMDs in later years (as a result of potential account growth over time) can push retirees into higher tax brackets, potentially negating the tax savings of earlier years.
3. Missed Opportunities for Enjoyment:
   Retirement savings aren’t just about preservation—they’re meant to fund a fulfilling lifestyle. By strictly adhering to minimum withdrawals, many retirees may unintentionally limit their desired quality of life.

Why Do Retirees Stick to the Minimum?

Several factors contribute to this conservative approach:

• Tax Concerns: Retirees often fear bumping into higher tax brackets. While this is a valid concern, strategic planning can mitigate the impact and keep you within your desired bracket.
• Tax Advantaged Growth: Retirees may want to leave as much as possible in the IRA to continue to experience tax-deferred growth.
• Legacy Planning: Many retirees wish to leave a substantial inheritance. While noble, this may sacrifice your desired retirement lifestyle. Also, leaving a larger IRA balance to your heirs may lead to larger taxable distributions for them given that most non-spouse beneficiaries need to draw the full balance from the inherited IRA in 10 years.
• Saver’s Mentality: Decades of disciplined saving can make it psychologically challenging to shift into a spending mindset.
• Uncertainty About Future Expenses: Medical costs, long-term care, and other unpredictable expenses may cause retirees to err on the side of caution.

Rethinking Your Withdrawal Strategy

To avoid falling into the “minimum only” majority, consider these strategies:

1. Optimize Withdrawals Early:
   In the years leading up to RMD age, explore Roth conversions or strategic withdrawals to reduce taxable account balances. This can spread the tax burden over more years and lower future RMDs.
2. Adopt a Holistic Retirement Planning Approach:
   Think of your retirement savings as part of a larger financial picture. Factor in Social Security, pensions, brokerage accounts, and other income sources to develop a comprehensive withdrawal plan.
3. Consider Spending Patterns:
   Figure out how your spending may look in years 1-5 of retirement, years 5-10, and so on. Figure out where most of your spending will go and how it may change in certain areas as time goes on.
4. Work with a Fiduciary Financial Advisor:
   Partnering with a fiduciary financial advisor like our team at Tenet can help you calculate the optimal withdrawal amounts, considering factors like life expectancy, inflation, and tax efficiency.
5. Leverage Charitable Contributions:
   If philanthropy is part of your legacy plan, Qualified Charitable Distributions (QCDs) allow you to donate directly from your retirement account, reducing taxable income while supporting causes you care about.

Considerations for 2025: Updated RMD Rules

The retirement landscape continues to evolve, and 2025 brings some changes pertaining to RMDs, especially related to inherited retirement accounts. The SECURE Act and SECURE Act 2.0 made changes to RMDs for inherited IRAs, particularly requiring that most non-spouse beneficiaries liquidate the account within 10 years of the original account owner’s passing. Initially, there was confusion around whether annual minimum distributions needed to be taken in years 1-9, or if beneficiaries could simply wait until year 10 to distribute all of it. The IRS has since clarified their stance, and the following is effective for 2025:

• If the original account owner passed away before they started RMDs: The beneficiary must withdraw the entire balance of the inherited IRA by the end of the 10th year following the original owner’s death.  However, annual distributions are not required during years 1-9.
• If the original account owner passed away after they started RMDs: The beneficiary must withdraw the entire balance of the inherited IRA by the end of the 10th year following the original owner’s death, and annual RMDs are required in years 1–9 (based on the beneficiary’s life expectancy, calculated using the IRS Single Life Expectancy Table).
• Note: While these are the most common cases, there may be instances where the beneficiary is considered an “eligible designated beneficiary” (e.g., a minor child of the deceased, a disabled or chronically ill individual, or someone not more than 10 years younger than the deceased), in which case they may qualify for the stretch IRA option where distributions can be taken over their life expectancy instead of the 10-year rule.

Two other 2025 RMD changes include:

• RMD Penalty Reduction
• The penalty for failing to take an RMD was reduced to 25% of the missed amount (down from 50%).
• If corrected promptly, the penalty is further reduced to 10%.
• RMDs Eliminated for Roth Accounts in Employer Plans
• Effective fully in 2025 for implementation, Roth 401(k) and Roth 403(b) accounts are no longer subject to RMDs during the owner’s lifetime, which aligns them with Roth IRAs.

Additional Planning Considerations:

• Potential Tax Implications: These withdrawals count as taxable income, which can push beneficiaries into higher tax brackets without careful planning.
• Strategic Roth Conversions: For retirees concerned with the future tax impact of RMDs (both for themselves and their heirs), they may look to proactively convert all or a portion of their IRA to a Roth IRA ahead of time.  While the conversion is taxable at your ordinary income tax rate, you pay the tax now for the benefit of future tax-free growth potential, tax-free withdrawals, and no RMDs.  When beneficiaries eventually inherit the Roth account in the future, they will need to liquidate the account in 10 years of the original owner’s passing, but annual distributions in years 1-9 are not required and distributions are tax-free.
• Legacy Planning Adjustments: Estate planning may need revisions to reflect the changes in withdrawal timing and tax impacts.

Being proactive with these new rules can save significant tax liabilities and help manage the inheritance process more smoothly.

Final Thoughts: Empowering Your Retirement

RMDs are a complex but crucial aspect of retirement planning. Understanding the rules, avoiding common mistakes, and adopting a deliberate withdrawal strategy that aligns with your overall financial plan can help you maximize your retirement savings and live the life you’ve worked so hard to build.

Feeling overwhelmed and unsure of how to handle RMDs in retirement, and your retirement withdrawal planning overall, is very common.  Having a trusted partner by your side to help guide you through the years and be your advocate can be tremendously valuable.

Our team at Tenet is here to help.  Don’t hesitate to reach out to our team with any questions or feel free to schedule a meeting with us!

Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., a SEC Registered Investment Advisor. Tenet Wealth Partners is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC.

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