RMDs Explained: The Retirement Tax Bomb Nobody Warns About

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RMDs: The Retirement Tax Bomb Nobody Warns You About

Today we are going to talk about RMDs—required minimum distributions. IRS makes the rules, we just play the game, don't shoot the messenger.

Let's dive in.

The Herd Mentality That's Costing You

If you've spent any amount of time in my space, you know that I'm not necessarily a fan of herd mentality. Herd mentality, especially around investing, actually ends up costing you so much money over your lifetime.

And one of the herd mentalities that's out there is that if you max out your 401k, or you're maxing out your IRA, or your SEP, whatever, every single year, that you're giving yourself a tax break. And that's really good, right? Well, in theory, but as you know, I'm a holistic financial planner.

And so that means that for many of you, I've walked through your life with you financially for like 10 and 20 years. And what I know that I know that I know is that very few people understand what happens when we pull the plug on our job and say, "I'm done working for you. And I'm ready to start actually turning my 401k or that IRA into income."

The implications are huge.

The Retirement Awakening Nobody Prepared You For

And I find that most of my clients feel like they were duped when they get into retirement because they didn't understand it. So let's just talk through this again. I want to remind you that I have three videos on my website that talk through the wall of shame and the way that different investment accounts are taxed. So if you don't know what I'm talking about, that's a great point of reference.

You save in an IRA or a 401k throughout your life. And then as you move through different jobs, you have somebody like me, who's like, "Don't leave your money over there with your old employer, consolidate." And so you end up consolidating these accounts and they become your IRA by the time you retire and it's future income.

But remember, what you've done is you have kicked the tax bill or kicked the tax can down the road over your entire lifetime. And you got your tax break when you filed your taxes in the years as you earned.

The Stiff Drink Reality Check

And then all of a sudden, you no longer have a job and you're switching from earning money every day and every week and paying taxes on your paycheck to now paying taxes on your savings. And it is a stiff drink and a rude awakening.

So I find that when my clients call and say, "Okay, hey, I want $4,000 a month deposited into my bank account from my IRA," and I say to them, "Okay, no problem. What we're going to do is I'm actually going to send you $4,000 a month. And we're also going to send the IRS a thousand dollars every month. So really it's costing you $5,000 a month for this $4,000. It's no different than paycheck money."

And that's when my clients go, "What, what did you just say?" I'm like, "Oh yeah, absolutely. If you want $30,000 to remodel your kitchen, no problem. But I am going to have to send $10,000 to the IRS immediately."

This is when people pause and try to understand the train wreck that is hitting their finances.

Why People Stop Spending Their Own Money

So what people do is they say, "All right, fine. That's all right. I'm not going to remodel that kitchen." And they wait because they don't want so much of their retirement income, especially in the front end of retirement to actually go to the IRS.

And so people are very reticent to actually spend the money in their IRAs or their former 401ks. And the IRS knows this. They know it's a bait and switch. You got your tax deduction way over here. Haha. Joke's on you. Now you're in a higher income bracket, higher tax bracket, and you're going to pay the piper if you want to even touch $1 of your 401k money.

The IRS Forces Your Hand

IRS knows this. And so they created a rule, which is basically a forced withdrawal rule where they're like, "Yeah, you're done. You've had your tax break all these years. Now you're age 73. Now you're age 75. And dude, we don't care if you don't want the money or not. You got to take it."

Why? Solely for the purpose of taxing you. Nice, huh?

When the RMD Nightmare Begins

Here's when it starts. If you were born 1951 or later, you have until age 73 to delay taking money out of your IRAs and 401ks.

So let me give you an example. If you had a $500,000 account at age 73, we have to send you about $18,000 a year, whether you want it or not, just so it can be taxed.

Oh, and if you miss it, you get a 25% penalty on the amount that you should have withdrawn.

But Wait, There's More: The Inheritance Tax Bomb

What if you die? Your heirs get exactly 10 years to distribute all of that income.

So imagine this. What if you have a kid that's working for aerospace or Boeing, and they're already making $150,000 a year, and now they've inherited your $500,000 IRA? Boo-hoo on them, right?

Well, let's think about this. Now they have to start taking income. They have to distribute all $500,000 of it to themselves over 10 years, and it doubles their tax bill.

Let me tell you, I've seen this firsthand, and it makes people real cranky.

Trust Won't Save You

P.S., IRAs are not protected. You can't stop RMDs from happening if you put an IRA in a trust. Nope, not even a little bit.

What Do You Do?

You plan. You learn from me about how to create tax-free pots of money. But really, there's nothing you can do to avoid it.

If you're younger, we need to talk about where you save money for retirement and not just follow the herd mentality. If you're older, we need to talk about some strategies that are going to work to minimize your tax bill and maximize the money coming out of your 401k.

The Bottom Line

The IRS has created the ultimate bait and switch with traditional retirement accounts. You get a small tax break today and pay a massive tax bill later—when you can least afford it and have the least control over it.

You know who I am. You know how to find me. We'll talk soon.