Understanding the Implications of Required Minimum Distributions on Your Taxes

As you approach your early 70s, you need to be aware of a financial deadline: required minimum distributions (RMDs) or mandated withdrawals from tax-deferred retirement accounts.

RMDs can have major tax impacts. Failing to plan for them — or forgetting to take them — can lead to unexpected tax bills, higher Medicare premiums and even penalties.

In this guide, we explain how RMDs work, their impact on taxes and strategies for navigating this retirement plan rule.

What are required minimum distributions?

An RMD is money that you must withdraw annually from certain retirement accounts once you reach the required age. That age used to be 70.5, but the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 raised the age to start taking RMDs to 72, starting in 2020.

The SECURE Act 2.0, passed in 2022, took the legislation further, creating a two-step increase to the age at which you must start taking RMDs. You’ll start at:

• 73 if you were born between 1951 to 1959
• 75 if you were born in 1960 or later

If you were born in 1950 or earlier, you’ll still take your RMD based on the rules from previous legislation. This means 72, or 70.5 if you turned 70.5 before 2020.

RMDs apply to tax-deferred retirement accounts including:

• Traditional IRAs
• 401(k), 403(b), and 457(b) plans (unless you’re still working and not an owner of the business)
• SEP and SIMPLE-IRAs
• Inherited retirement accounts

You are not required to take RMDs from Roth IRAs or Roth 401(k) accounts during your lifetime.

How do you calculate your RMD?

The amount you must withdraw is based on your account balance as of December 31 of the previous year and an IRS life expectancy factor. IRS Publication 590-B includes a worksheet for calculating RMDs and tables with the life expectancy factors.

Each year, the factor decreases, meaning the percentage of your balance you must withdraw increases over time.

How RMDs affect your taxes

RMDs are taxable as ordinary income, meaning you generally pay federal and, in many cases, state income taxes on your withdrawals. They can affect your tax bill in several ways.

Pushing you into a higher tax bracket

The United States has a progressive tax system, meaning higher tax rates apply to higher income levels. RMDs can push you into a higher tax bracket.

Additional taxes on Social Security benefits

More than half of Social Security recipients pay taxes on their benefits. You likely will too if you have income from other sources. The amount you pay depends on your filing status and your combined income for the year.

Combined income is the adjusted gross income (AGI) on your tax return, plus any nontaxable interest, plus half of your Social Security benefits.

RMDs can lead to paying more tax on Social Security benefits. The table below shows how much of your benefits are taxable.

Medicare premium increases

Medicare Part B and Part D premiums are income-based. For most people, the federal government pays about 75% of Part B premiums, and the beneficiary pays the remaining 25%.

However, a higher taxable income due to RMDs could push you into a higher income-related monthly adjustment amount (IRMAA) bracket. This means you could pay up to 85% of your Medicare Part B premiums plus an additional premium for your Medicare prescription drug coverage.

State taxes

You may also owe state income taxes on your RMDs. Eight states — Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming — don’t have a state income tax, and New Hampshire only taxes interest and dividend income. Some states fully exempt retirement income from taxes, while others have special rules for retirement accounts, Social Security benefits and pensions.

It’s a good idea to work with a tax professional who’s familiar with the laws in your state to understand how RMDs will impact your state income tax liability.

Potential for penalties

Failing to take your RMDs (or taking less than the required amount) can lead to steep penalties. If you don’t withdraw the required amount by the deadline, you’ll owe a penalty of 25% of the amount not withdrawn (10% if you correct your withdrawal within two years).

Tips to minimize the burden of RMDs

RMDs may be unavoidable, but there are a few ways to reduce their tax impact:

• Delay RMDs with the still-working exceptions. If you’re still employed and own less than 5% of the business, you can delay taking RMDs from your employer-sponsored plan, such as a 401(k) plan, until you retire. However, this exception doesn’t apply to traditional IRAs.
• Do a Roth conversion. Since Roth IRAs don’t have RMDs during your lifetime, converting some pre-tax retirement savings into a Roth can help lower future RMDs. Just keep in mind that Roth conversions generate taxable income in the year of conversion, so it’s best to do these in low-income years when you have cash available for the tax bill.
• Use qualified charitable distributions (QCDs). A QCD allows you to donate up to $100,000 annually directly from your IRA to a qualified charity. This donation satisfies your RMD for the year but you can exclude it from your taxable income.
• Have taxes withheld from your RMD. You usually have the option to have federal and state income tax withheld from your RMD. While this reduces the amount you receive, it can prevent an unexpected tax bill and help you avoid underpayment penalties and interest.

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Matt Schulz is the Chief Credit Analyst at LendingTree and has been covering the personal finance space for more than a decade. He is a nationally recognized expert on credit cards, “buy now, pay later” loans, personal loans, credit scoring and reporting, small business lending and other aspects of personal finance. He’s been quoted in or appeared on Good Morning America, NBC Nightly News, The Wall Street Journal, The New York Times and hundreds of other media outlets around the U.S. and the world. He is a graduate of the University of Texas and lives in Austin with his wife and son.