Dear Fix My Wallet,
I will be 73 this year and will have to withdraw about $53,000 from my retirement accounts for the RMD. This will add about $5,000 to my tax bill for 2024. If I get the full $53,000 today, will I have to pay the IRS quarterly estimated taxes of $1,250 each during the 2024 tax year? But if I wait until December 2024 to get the full $53,000, will I have to pay tax on the $5,000 when I file my 2024 taxes in April 2025? I can't seem to find an answer to this, so any help would be greatly appreciated,
Dave
Do you have a question about investing, how it fits into your overall financial plan and what strategies can help you make the most of your money? You can write to me on beth.pinsker@marketwatch.com. Please put Fix My Portfolio in the subject line.
Dear Dave,
Welcome to the wild world of required minimum distributions. Merry Christmas, and many happy tax returns.
For some people, this is the land of rainbows and unicorns, where they happily spend the money they saved while working and doing what they like. For others, it's just a massive tax headache and somewhat intrusive to have to withdraw money you may not need for living expenses, in order to finally give the government its share after years of tax-free growth.
From your letter I can't exactly tell which camp you fall into, but I do feel a little frustrated with the decisions made and how difficult it is to find the information you need.
There's some good news for you, though, as this isn't as hard to figure out as it might seem at first glance (but it's not exactly obvious either).
Calculate the amount required for withdrawal
The easy part is that the amount you are required to withdraw is a knowable amount and will not change no matter when or how you take the RMD. It is based on the balance of your deferred tax accounts as of December 31 of the previous year. So, if that balance was $1.5 million at the end of 2023, you would apply the IRS formula relevant to your situation, and come up with a figure close to $55,000 that you would have to withdraw, as I did. Take it now, take it monthly, take it at the end of the year: there are pros and cons to every strategy. The only bad way is to forget to take it completely because you could face severe penalties.
Another potential plus: When you turn 73, your first RMD won't be due until April 1 of the following year. So you may have more time than you thought, but you can take it whenever you want. Most people need their retirement money to cover living expenses and get what they need when they need it, often exceeding the required amount, or find other ways to spend the money such as gifts to family or charity.
Taxes owed are a little more complicated, because people are complex and every tax situation is different. It's easy to say something like you're in the 10% tax bracket, so adding $55,000 of income would make your tax bill on that amount about $5,500. It could end up being either more or less. Your total tax burden for the year will depend on your other income, deductions and credits. Additionally, you may have state taxes where you live. If this extra income pushes you over certain limits, you may end up paying more in taxes on your Social Security, and you may incur an additional Medicare fee known as IRMAA.
Your custodian can automate your tax withdrawals
But let's get back to the easy stuff, because you can automate this and never think about it again. Your account custodian should be able to deduct taxes from any withdrawals and send you a tax statement at the end of the year – certifying the principal amount of the RMD from the previous year and showing the taxes withheld.
“This may be one way to help yourself stay out of hot water,” says Nilay Gandhi, a certified financial planner and senior wealth advisor at Vanguard.
If you end up paying too much in a year this way when it's all counted on the 1040, you can settle that on your next filing and get your money back, just as you would if you withheld too much of your paycheck.
If you choose to handle this yourself, yes, you will owe estimated taxes throughout the year and will have to stay on top of this filing process. We all owe income tax throughout the year on the periodic or gross income we receive, whether it's a paycheck, Social Security, or tax-deferred withdrawals, and we don't tend to think of it that way. We settle into April of the following year when our tax returns are due, and we think of that as when we actually pay our taxes.
One reason many financial advisors steer their clients toward taking their RMDs at the end of the calendar year rather than the beginning is because of this tax issue. You know more about your overall financial situation for the year in November than you do in January.
Gandhi says: “Measure twice, cut once.”
You also get the benefit of tax-deferred growth on the RMD amount throughout the year. You know that on January 1st you have to withdraw $55,000, but that will likely earn $2,750 in interest at 5% by the end of the year. You still only have to withdraw $55,000. This additional growth continues to compound your tax break, rather than you owing more taxes.
