The IRS rule that forces retirees to pay taxes on money they never touched

Many retirees have the same reaction when they first hear about Required Minimum Distributions (RMDs).

You spent decades carefully saving for your retirement plan. The money in your retirement account has been growing tax-deferred, and you may not even need it yet. But the IRS says you must start withdrawing a portion anyway, and paying taxes on it.

That rule often catches retirees by surprise. Unexpected tax bills tied to RMDs can complicate plans for a stress-free retirement, and knowing how it works can help retirees avoid penalties and manage the tax impact.

Required Minimum Distributions

Under the SECURE 2.0 Act, Required Minimum Distributions are the minimum amounts retirees must withdraw each year from certain tax-deferred retirement accounts.

The rule applies because those accounts were funded with pre-tax contributions or allowed earnings to grow tax-deferred. The government eventually wants to collect the income taxes that were postponed during your working years.

RMDs typically apply to traditional IRAs, 401(k) plans, 403(b) plans, and most other tax-deferred retirement accounts. They do not apply to Roth IRAs during the original account owner's lifetime, because those accounts were funded with after-tax money.

When the withdrawals begin

The next key question is when these required withdrawals begin. Required Minimum Distributions generally begin at age 73, and your first RMD must be taken by April 1 of the year after you turn 73. After that, withdrawals must be taken by December 31 each year.

While delaying the first distribution until April may sound appealing, it can create a tax complication. If you delay the first withdrawal into the following year, you will still have to take that year's RMD by December 31. That means two taxable withdrawals could occur in the same year.

How the required amount is calculated

The amount you must withdraw each year is based on a formula using your account balance and an IRS life expectancy table. At the end of each year, you look at the balance in your retirement account and divide it by a life expectancy factor provided by the IRS.

For example, someone who turns 73 might divide their retirement account balance by roughly 26.5 under the IRS Uniform Lifetime Table. A retiree with a $500,000 traditional IRA would therefore be required to withdraw about $18,900 for the year. That withdrawal is treated as taxable income in most cases.

The percentage increases each year gradually as the life expectancy factor declines, which means required withdrawals typically grow over time.

Why retirees feel blindsided by RMDs

Many retirees plan carefully around their spending needs. Some intend to leave retirement accounts untouched for a while so the money can continue growing. Others rely primarily on Social Security, pensions, or other income sources and do not need withdrawals right away.

RMDs disrupt that plan. Even if you do not need the money, the IRS still requires the withdrawal. Once the funds come out of the account, they become taxable income for the year. That additional income can sometimes push retirees into a higher tax bracket or increase the portion of Social Security benefits that become taxable.

In certain cases, higher income can also affect Medicare premiums through a system known as Income Related Monthly Adjustment Amounts, often called IRMAA. These surcharges increase Medicare Part B and Part D premiums for retirees whose income exceeds certain thresholds.

Missing a withdrawal

Failing to take a Required Minimum Distribution can lead to a penalty. The penalty is currently 25% of the amount that should have been withdrawn. If the mistake is corrected quickly, the penalty may be reduced to 10%.

For instance, if a retiree was supposed to withdraw $20,000 but failed to do so, the penalty could be $5,000. Because of the size of the penalty, it is important to track RMD requirements carefully once they begin.

Many financial institutions provide reminders or even calculate the amount automatically, but the responsibility ultimately rests with the account holder.

How RMDs can affect taxes in retirement

Required Minimum Distributions often arrive at a time when retirees are trying to control their taxable income. Withdrawals from traditional retirement accounts are generally taxed as ordinary income. When combined with Social Security benefits, pension income, and investment earnings, RMDs can increase the overall tax bill.

Some retirees are surprised to discover that withdrawals they did not plan to take can shift them into a higher tax bracket or trigger additional Medicare costs, which is why many financial planners encourage retirees to think about tax planning before RMDs begin.

Strategies that can help manage the impact

Although RMDs cannot be avoided once they begin, there are ways to reduce their tax impact. One option is a qualified charitable distribution. Retirees age 70 and a half or older can transfer money directly from an IRA to a qualified charity. The donated amount can count toward the required distribution, but is not included as taxable income.

Another strategy some retirees consider is gradually converting portions of traditional retirement accounts to Roth accounts before reaching age 73. Roth accounts do not have required minimum distributions during the original owner's lifetime, which can provide more flexibility later.

Some retirees also choose to take withdrawals earlier in retirement while their overall income is lower. Spreading withdrawals across several years may reduce the chance of large taxable distributions later.

Bottom line

Required Minimum Distributions can feel frustrating for retirees who would prefer to leave their savings untouched.

Once you reach age 73, the IRS requires annual withdrawals whether you need the money or not. While the rule may not feel convenient, planning ahead can make these withdrawals easier to manage and become an important part of money moves around senior benefits.