Whether you are already retired or still planning your retirement strategy, you need to consider your strategy for when you reach the age at which the required minimum distributions (RMDs) begin.
Planning ahead can help reduce taxes and increase options for continuing to reinvest tax-advantaged savings. There are a few important things to know when getting started with your RMD planning.
- According to federal law, you must start withdrawing from your retirement account by a certain age to avoid penalties.
- Generally, if your 70th birthday is July 1, 2019, or before, you would have been required to begin required minimum distributions no later than 2020.
- Due to the SECURES ACT, if your 70th birthday is after July 1, 2019, you must begin taking RMDs by April 1 in the year after you turn 72 and continue with minimum distributions by December 31 every year after that. (Note: if you delay your first RMD until April of the year after you turn 72, you’ll be required to take a second RMD by December 31 in the first year you take required minimum distributions.)
- The only tax-advantaged retirement funds you can keep indefinitely are Roth IRA funds (no RMD applies unless they are inherited).
- Don’t miss your RMD deadline because the IRS penalty can be severe — 50% of the amount not taken on time.
- RMDs are not a set amount that you take each year. You must take out at least the required minimum distribution amount, but you can also take more.
What is the Required Minimum Distribution?
A Solo 401k gives you a great opportunity to defer paying taxes so that you can invest and grow your savings for many years. However, the taxman does want part of your money eventually, and that is what Required Minimum Distributions are all about. Your goal is to grow your retirement savings to a much larger amount than you could have if the taxes were not deferred. And then minimize the taxes that you do pay when you begin taking distributions.
The IRS taxes Required Minimum Distributions the same way it taxes other ordinary income. Each year that you take a withdrawal from your Solo 401k or other retirement accounts, it will count toward your total taxable income for the year. The IRS will tax your total applicable income at the individual federal income tax rate, and it may also be subject to state and local taxes. If you have made contributions to an after-tax retirement account, such as a Roth Solo 401k or Roth IRA, the distributions from these accounts will not be taxed. However, these distributions are first added to your total income for the year, but your taxable income should be reduced proportionately for the after-tax contributions.
One of the key things that you want to manage during retirement is the tax bracket that will apply. This income increase may push you into a higher tax bracket and may also impact the taxes you pay for your Social Security and/or Medicare.
How Are Required Minimum Distributions Calculated?
Your Required Minimum Distribution is generally determined by dividing the adjusted market value of your account(s) as of December 31 of the preceding year by the distribution period that corresponds with your age in the Uniform Lifetime Table. There are three Uniform Lifetime Tables that are found in IRS Publication 590-B.
Table I is used if you are an individual and a beneficiary but not the owner’s surviving spouse and the sole designated beneficiary. Or the beneficiary isn’t an individual, and the owner died on or after the required beginning date (defined earlier). If you are the original account owner, your RMD is calculated by dividing prior year-end account balances by a life expectancy factor in the IRS Uniform Lifetime Table I. Figure your required minimum distribution for each year by dividing the account balance as of the close of business on December 31 of the preceding year by the applicable distribution period or life expectancy.
Table II is for joint life and last survivor expectancy. It is for account owners whose spouses are more than ten years younger and are the sole beneficiaries. For your first distribution, by the required beginning date, use your age and the age of your designated beneficiary as of your birthdays in the year you become age 72. Your combined life expectancy is at the intersection of your ages.
Table III is used by unmarried account owners, married owners whose spouses aren’t more than ten years younger, and married owners whose spouses aren’t the sole beneficiaries. This is the most commonly used. To figure the required minimum distribution, divide your account balance at the end of the year the RMD is due by the distribution period from the table.
Where Do I Learn the Rules Regarding Required Minimum Distributions?
Note: IRS Publication 590-B deems a “qualified employer plan”’ as an IRA. A Solo 401k is a qualified employer plan. For distribution purposes, the Solo 401k closely follows the IRA rules. However, you will find other relevant information about Solo 401k plans in IRS Publication 560.
One difference between IRA and Solo 401k minimum required distributions is that if you have more than one defined contribution plan (Solo 401k), you must calculate and satisfy your RMDs separately for each plan and withdraw that amount from that plan. However, if you have multiple IRAs, you may aggregate your RMD amounts for all your IRAs and withdraw the total from one IRA or a portion from each of your IRAs. You do not have to take a separate RMD from each IRA. You will find other comparisons of the two different accounts on this IRS comparison page.
Planning For On-Going Distributions From Your Solo 401k
Once you begin Required Minimum Distributions, you will need to take a minimum distribution in each year that follows. You’ve earned wealth by compounding the earnings of your tax-advantaged Solo 401k savings. When your retirement years do arrive, you have the opportunity to draw down some or all that savings in the form of distributions.
However, you have major choices in how those distributions are taken.
- Nonperiodic, such as lump-sum distributions.
- Periodic, such as annuity or installment payments.
And you have the freedom to make other decisions. One possibility is retiring early because you can begin taking distribution long before Required Minimum Distributions take effect. For instance, you could retire as early as age 55. With rule 55, you will still owe income taxes on your withdrawals, but you won’t have to pay the 10% penalty. Your early retirement can begin as soon as age 55 if you meet two specific requirements:
- You are no longer employed by the company with whom the 401k is associated (including your Solo 401k business).
- You left that employer during or after the calendar year in which you reached age 55.
Rule of 59 1/2 – Alternate to Required Minimum Distributions?
More people are familiar with the rule of 59 1/2 because it doesn’t include any employment rules. At this age, you can start taking distributions from your plan without incurring a 10% penalty for early distribution. You’re allowed to take distributions from your Solo 401k even if you’re still actively working in your self-employment business, and even if you are also continuing to make new plan contributions.
In most circumstances, you wouldn’t both contribute and distribute, but it’s technically feasible to do so. Distributions from a tax-deferred account will be taxed as regular income to you. Qualified Roth distributions will be tax-free. If you retire at or after 59½, you can start taking withdrawals without paying the IRS early withdrawal penalty. This can be one way to access your retirement funds before you start taking Required Minimum Distributions.
Rule of 72 Distributions
Required Minimum Distributions aren’t the only way to get funds out of your retirement plan. Another way to retire early is rule 72t. According to the Substantially Equal Periodic Payments rule, you can withdraw from your Solo 401k or other qualified retirement accounts and IRAs without a penalty. But only IF you take them in equal periodic payments. Some rules must be closely followed, with one being selecting between the three options for calculating your SEPPs and each is significantly different. The three allowed methods are:
- Amortization method
- Minimum distribution (or the life expectancy method)
- Annuitization method
These calculations are not simple to do, but you do want to understand each before making your decision. All three methods require using the life expectancy table. The first and third methods (amortization and annuitization) also require you to use a realistic interest rate. Making the right decision the first time can be important because IRS Rev. Rul. 2002-62 only allows a one-time change from either the amortization method or the annuitization method. Otherwise, you’ll almost certainly owe the 10% penalty plus interest.
Other Distribution Factors to Consider
- Age 62 – You can choose to begin receiving Social Security income at this age. But if you defer Social Security, the size of your monthly check will increase until your reach age 70.
- Age 65 – Eligibility for Medicare begins. This is the government’s retirement health insurance program. It’s a time when you may also want to purchase a private “Medigap” insurance policy to help with copayments and deductibles not covered by Medicare.
- Age 66 – is the Social Security ‘full retirement age’ if you were born between 1943 and 1953. For those born after 1953, there is a prorated scale for full retirement age that reaches 67 for those born in 1960 and later.
- Age 70 – This is the age for the largest possible monthly Social Security benefit if you’ve waited to begin receiving payments. Your benefit could be as much as 76% larger than if you had started receiving payments at age 62.
Non-qualified Roth distributions can be a choice for some people. If a Roth distribution is non-qualified, then the earnings portion of the distribution is taxable but the part you already paid taxes on (contributions) is not taxable as long as you have held the account for five years or more. Unlike in an IRA where there is a first-in first-out logic applied to contributions, conversions, and earnings, all Roth 401k distributions are treated on a pro-rata basis. This means that if you have a non-qualified distribution, you must calculate which portion is on a non-taxable basis and which is taxable earnings.
How to Properly Take Distributions
The distribution process. A Solo 401k or Roth 401k offers many ways to take distributions while minimizing taxes at the same time. Many people will wait until one of the traditional retirement ages and set up a distribution process that makes financial sense to help them well into their golden years. You are in control. With a Solo 401k, you are the plan administrator. This means you are responsible for a distribution process that makes the most sense to you. You are also responsible for recordkeeping to track the values of your respective plan accounts, executing plan distributions, and performing the necessary tax filings.
We strongly recommend you work with your professional tax advisor on Solo 401k distributions. The act of taking a Solo 401k distribution is easy. You just issue funds from the plan to yourself. However, on the back end, there are a few activities you need to document to make this a legitimate distribution. If you have multiple accounts such as husband & wife or tax-deferred & Roth, you will need to update your plan ledger to indicate which participant account(s) funds were distributed from and update the current value of those accounts.
Set Up Your Solo 401k for Tax-Advantaged Real Estate Investing
You can invest your Solo 401k funds into houses, condos, raw land, mortgage notes, and more! Let the gains, rents, and profits go back into your Solo 401k without taxation. With a Nabers Group Solo 401k you the freedom to invest in virtually any real estate deal, whether it be a local rental home, an out-of-state rental property, a bargain at the foreclosure auction, or a syndicated “insider” real estate development.
Real Estate has long been the darling of the self-directed investing industry, but there are many other alternative assets that you might also want to consider.
Opening your Solo 401k involves very little work for a ton of benefits.
