RMD Rules and Strategies Every Law Firm Owner Must Know (Ep. 94)

Written By Courtney Grayson

As a law firm owner, your financial independence hinges on how well you manage your retirement savings. One critical aspect you cannot afford to overlook is Required Minimum Distributions (RMDs). Missing an RMD deadline could cost you 25% of your withdrawal, a potentially hefty penalty. In this comprehensive guide, we’ll break down everything you need to know about RMDs—what they are, when to start, and how to avoid common mistakes.

What Are RMDs?

RMDs, or Required Minimum Distributions, are mandatory withdrawals you must take from certain tax-deferred retirement accounts once you reach a specific age. These accounts include:

  • Traditional IRAs

  • SEP IRAs

  • SIMPLE IRAs

  • 401(k)s

The primary purpose of RMDs is to ensure the IRS eventually collects taxes on these accounts, which have grown tax-deferred during your working years.

Why Should Law Firm Owners Care About RMDs?

Failing to take your RMDs on time results in a significant penalty—25% of the amount you should have taken. Suppose your RMD is $20,000 and you miss it. You could face a $5,000 penalty. That’s a steep price to pay for an oversight.

Additionally, large forced withdrawals can push you into a higher tax bracket, increasing your federal and state taxes, taxes on Social Security benefits, and even Medicare premiums. Therefore, proper planning is essential to protect your hard-earned savings.

When Do You Need to Start Taking RMDs?

RMDs kicked in at age 70.5 for the longest time. However, if you were born between 1951 and 1959, your RMDs now start at age 73. For those born in 1960 or later, the starting age is 75. Your first RMD must be taken by April 1st of the year following the year you turn the required age.

Calculating Your RMD

Calculating your RMD may seem complicated, but it's essentially a formula involving:

  • Your account balance on December 31st of the previous year.

  • Your life expectancy factor, as determined by IRS tables.

For example, the initial life expectancy factor at age 75 is 22.9. This essentially means you would divide your account balance by 22.9 to determine your RMD.

Key Exceptions and Considerations

There are some notable caveats and exceptions related to RMDs:

  1. Still Working Exception: If you are still working and own less than 5% of your law firm, you may delay RMDs from your 401(k) until retirement. However, this exception does not apply to IRAs.

  2. Roth IRAs: These accounts do not have RMDs during your lifetime, providing extra flexibility in retirement planning.

Advanced Strategies to Minimize Tax Impact

  1. Qualified Charitable Distributions (QCDs): If you’re 70.5 or older, you can donate up to $100,000 annually directly to a qualified charity from your IRA. This satisfies your RMD and excludes the donated amount from your taxable income.

  2. Roth Conversions: Gradually convert funds from your traditional IRA to a Roth IRA to reduce the amount subject to RMDs. This strategy is particularly effective during lower income years to avoid bumping into a higher tax bracket.

  3. Preemptive Distributions: Start taking withdrawals before RMDs are required to spread out your tax liability over a longer period.

  4. Beware the Double Distribution Trap: If you delay your first RMD until April 1st, you will have to take two distributions within the same tax year, potentially increasing your tax bill.

Taking Control of Your RMD Strategy

To avoid costly mistakes, it’s essential to:

  1. Know Your Deadlines: Keep track of when your RMDs are due.

  2. Plan Proactively: Work with a financial planner to develop a personalized strategy that aligns with your goals.

  3. Consider Automation: Spread your RMDs throughout the year by automating monthly withdrawals.

  4. Explore Tax-Saving Strategies: From QCDs to Roth conversions, plan ahead to minimize your tax impact.

Secure Your Financial Future Today

Managing RMDs is more than a compliance issue; it’s about making smart financial decisions to protect your wealth. At The Lawyer Millionaire, our mission is to help law firm owners like you build and secure a robust financial future. Schedule a free consultation with us today to create a tax-smart retirement strategy.

Resources:

Courtney Grayson
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