You Can’t Make Me! RMDs and Your IRA for the CFP Exam

Americans tend to be a pretty independent bunch. You can’t tell us what to do! Like with trans-fats in food: we didn’t even know what they were until the government wanted to take them away. Then we said, “Congress! Don’t mess with my Twinkie.”

We also don’t like being dictated to with regard to our retirement dollars. Currently, the majority of Americans save for retirement in Traditional IRAs, 401(k)s, and Roth IRAs. While these plans have many similarities, several key differences affect financial planners’ recommendations for individual clients.

You Can't Make Me! Well, They Can

A Traditional IRA – an account where you contribute tax-deferred dollars – specifies that you must take distributions of those funds at a certain age. For 2024, the IRS states, based on the SECURE 2.0 Act that you must begin taking RMDs to age 73. If you reach age 72 in 2023, the required beginning date for your first RMD is April 1, 2025, for 2024. Notice 2023-23 permits financial institutions to notify IRA owners no later than April 28, 2023, that no RMD is required for 2023.

If you reach age 73 in 2023, you were 72 in 2022 and subject to the age 72 RMD rule in effect for 2022. If you reach age 72 in 2022,

• Your first RMD is due by April 1, 2023, based on your account balance on December 31, 2021, and

• Your second RMD is due by December 31, 2023, based on your account balance on December 31, 2022.

Individuals born in 1951 must receive their first required minimum distribution by April 1, 2025. These “Required Minimum Distributions,” based on a formula of start-of-year account balance divided by a published life expectancy, wield a heavy penalty if not obeyed. Participants must pay taxes at their current tax bracket on the funds when distributed. Even if the IRA owner is in a lower tax bracket than during his or her working years, the tax burden can hurt because of the fixed income status of these retired clients.

A Roth IRA – an account where you contribute post-tax dollars – doesn’t require that you take any distributions during your lifetime. And when you do distribute, you pay no tax. You’ve already paid the piper, and now you get to dance for free. For a client on a fixed income, this kind of tax relief can make a big difference.

Another financial benefit of Roth IRA distributions is their exclusion from taxable income. Therefore, they don’t increase a taxpayer’s adjusted gross income (AGI). As a result, taxpayers taking Roth distributions instead of taxable distributions can reduce or eliminate the 3.8% Net Income Investment Tax (NIIT). In contrast, distributions from Traditional IRAs and most employer-sponsored retirement plans increase a client’s AGI and subject him or her to additional NIIT because the NIIT is assessed against the lesser of AGI in excess of an indexed amount or net investment income.

Depending on their current tax situation and the tax bracket of their retirement, be sure to consider recommending the Roth IRA to your clients. That helps mitigate the "you can't make me" vibe and might help you on the CFP exam.