Dear Fix My Portfolio,
I have a tax-deferred annuity, a traditional IRA and a 403(b).
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I turned 73 last year. I totaled my three balances as of Dec., 31, 2022, divided by 26.5 and withdrew that quotient from the 403(b). It was reported on a 1099-R as a normal distribution.
At the time I filed my 2023 taxes, my accountant told me that I should have withdrawn the RMD from each of my other accounts as well. Unfortunately, I think I botched up my first withdrawals.
Honestly, I don’t understand why any of this matters — as long as the final amount is correct. What accounts can be aggregated so I can compute my required minimum distributions each year?
These later withdrawals should happen soon, but unfortunately not by the tax deadline. I attempted to have these two withdrawals designated as my 2023 RMDs for those accounts. I’m not sure if that will happen.
I realize now I will be withdrawing even more money in 2024 because I will need to take those payments from my annuity and IRA, plus my RMDs for 2024 will also be due. What will that do to my taxes?
First-timer
Dear First-timer,
I spoke to a couple of experts to double-check your situation and none of us have any real answer why it matters what money comes from which accounts when it comes to required minimum distributions, but we all know that it does. It matters so much that it costs a lot when you get it wrong.
RMDs are confusing and the rules change a lot. The IRS just tweaked a consequential RMD rule in the middle of April, right after the tax deadline. For 2024, those who inherited IRAs after 2019 — who are non-spouses or aren’t otherwise excluded — won’t be penalized if they skip RMDs on those accounts. The IRS is still sorting out how RMDs will apply to these accounts permanently.
“They’re still working on interpreting it. But that particular one is puzzling, because it’s not that complicated of a question,” says Rob Williams, managing director of financial planning at Charles Schwab SCHW.
For the latest RMD change, most people may not even want to change their behavior and skip their distributions, because the money needs to be emptied out of inherited IRAs within 10 years. If you skipped the past few years when the RMDs were waived, and also sit out 2024, you could end up sitting on a big tax bill down the road.
“There’s a tradeoff,” says Williams. “There might be a benefit to continuing to invest tax-deferred, but we’re generally telling people just because you can wait, doesn’t mean you should. It depends on your situation.”
All RMDs are not created equal
When you’re dealing with your own tax-deferred accounts that are subject to required minimum distributions starting now at 73, you also have to think broadly and long-term. What you did was lump together all of your accounts, thinking money is money. It’s not illogical, but it’s not how the IRS thinks.
“Unfortunately you can’t aggregate like that,” says Eric Bronnenkant, head of tax at Betterment, a financial-adviser company headquartered in New York.
What you were supposed to do is calculate the amount due and pay three separate RMDs, based on the account balances at the end of the year and your applicable uniform lifetime table. That means one for the deferred annuity, one for the IRA and one for the 403(b).
Unless the deferred annuity was actually in a 403(b), you could combine it with the other 403(b), but not with the IRA. If the deferred annuity was in an IRA, it could be matched up. It would all depend on the type of IRA. Basically, the IRS says for this purpose that it’s only apples with apples, even though all money is green.
Again, you may ask why.
“I’ve had this conversation before with clients, and they say it doesn’t make any sense,” says Bronnenkant. “I don’t have a reasonable answer on that, but, ultimately the burden is on the taxpayer to make sure they take their required distributions following the rules.”
Fix it fast
You say you’ve put into motion a plan to fix this, but time is of the essence here to reduce your penalties. Normally, your deadline for taking your RMD withdrawals would be Dec. 31, 2023, but since this was your first one after turning 73, you would have had until April 1. But late is late. The most important thing to do is calculate the proper amount to take from the IRA and deferred annuity, and withdraw it.
Then you need to file Form 5329 with the IRS for a missed distribution with a letter of explanation. Don’t wait for that. The faster you do it, the less you might have to pay in penalty. And since it’s a first offense and you’re new to RMDs, they might even still forgive the transgression. If not, you’ll owe a penalty of just 10% if corrected within two years, and 25% if it’s later than that. Best to consult with a tax professional to make sure you file all of this information correctly and to the right IRS office for your filing address.
Then you will have to sort out your tax situation for 2024. It does seem like you’re going to have to take those two distributions and pay tax on them, plus take the three RMDs you owe for 2024 at some point in the calendar year. That may raise your income a bit.
There’s one thing you could do this year that could help: consolidate your green into apples, by which I mean, you could roll over your 403(b) into your IRA. “The withdrawal process has gotten to the point where it often requires some actual ‘strategy’ as to where, how and when to take the withdrawals,” says Pam Krueger, founder of Wealthramp, a service that pairs people with fee-only financial planners.
“And yes,” she adds. “The government has over complicated it for no good reason.”
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