Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs) are the minimum amounts that United States law requires you to withdraw annually from your tax-deferred retirement accounts once you reach a certain age. Think of it as Uncle Sam finally coming to collect the taxes he so patiently allowed you to postpone for decades. While you were working, your contributions and their investment growth in accounts like a Traditional IRA or a 401(k) were shielded from taxes. But the party doesn't last forever. The government, specifically the Internal Revenue Service (IRS), uses RMDs to ensure it gets its tax revenue from that accumulated wealth. The RMD rules are designed to deplete the majority of your retirement account over your lifetime. Forgetting or miscalculating your RMD can result in a painfully large tax penalty, making it a critical, can't-ignore topic for any investor approaching or in retirement. This is especially true for a value investor, as RMDs can force you to sell assets at precisely the wrong time.

At first glance, an RMD seems like a simple tax rule. But its consequences can ripple through your entire investment strategy, especially if you're a value investor who prefers to buy and hold great businesses for the long term.

• The Tax Bite: RMDs are typically taxed as ordinary income. A large RMD can push you into a higher tax bracket, significantly increasing your tax bill for the year and potentially impacting the taxation of your Social Security benefits.
• The Penalty Hammer: If you fail to take your full RMD by the deadline, the penalty is steep. For many years it was 50% of the amount you failed to withdraw. The SECURE Act 2.0 reduced this penalty to 25%, and it can be further reduced to 10% if you correct the mistake in a timely manner. While less severe, it's still a significant and easily avoidable penalty.
• The Value Investor's Dilemma: This is the big one for us. RMDs create a forced selling situation. Imagine the market has crashed, and your favorite high-quality stocks are trading at a deep discount. The last thing you want to do is sell them. But if you don't have enough cash in your retirement account to satisfy your RMD, you may be forced to liquidate these wonderful businesses at bargain-bin prices. This directly contradicts the value investing principle of selling high, not low.

Understanding the mechanics is the first step to mastering the RMD game. The rules can be a bit tricky, especially as they have changed in recent years.

The age at which you must begin taking RMDs depends on your birth year. The trigger age used to be 70 ½, was raised to 72, and is now 73 for individuals born between 1951 and 1959. RMD rules apply to most tax-deferred retirement plans, including:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k) plans
• 403(b) plans
• 457(b) plans
• Profit-sharing plans

The most notable exception is the Roth IRA. Original owners of a Roth IRA are never required to take RMDs during their lifetime. This is a powerful feature that provides significant tax and estate planning flexibility.

The calculation itself is straightforward in theory. You take your retirement account's balance from the end of the previous year and divide it by a distribution period factor provided by the IRS. The basic formula is: RMD = (Account Balance as of Dec 31 of Prior Year) / (Life Expectancy Factor) Most people will use the 'Uniform Lifetime Table' from the IRS to find their life expectancy factor. For example, if you are 75, your factor is 24.6. If your IRA was worth $500,000 at the end of last year, your RMD would be: $500,000 / 24.6 = $20,325.20 You must withdraw at least this amount during the current year.

Instead of viewing RMDs as a threat, a savvy value investor can treat them as a strategic puzzle to be solved. With some planning, you can satisfy the rules while keeping your long-term investment philosophy intact.

Don't wait until you're 73 to think about RMDs. Project your future account balances and potential RMDs. Will they push you into an uncomfortably high tax bracket? Planning years in advance gives you more options.

You have control over how you take the RMD, which is your secret weapon.

• Use Cash First: Always try to satisfy your RMD from any cash or money market funds sitting in your retirement account. This avoids selling any of your core stock holdings.
• Distribute “In-Kind”: This is a game-changer. You do not have to sell your shares! You can instruct your custodian to move the shares from your tax-deferred IRA directly to a taxable brokerage account. This is called an “in-kind” distribution. You will pay income tax on the market value of the shares at the time of the transfer, which satisfies your RMD. But the key is: you still own the company. The shares are now in a different account, ready to continue growing for the future.

A Roth Conversion involves moving money from a Traditional IRA to a Roth IRA. You pay income tax on the amount you convert in the year you do it. While it means a tax bill now, the major benefits are that all future growth and withdrawals from the Roth IRA are tax-free, and, as mentioned, there are no RMDs for the original owner. Strategically converting funds during low-income years or market downturns can be a powerful way to reduce or even eliminate future RMDs.

If you are charitably inclined and are age 70 ½ or older, you can use a Qualified Charitable Distribution (QCD). This allows you to donate up to $105,000 (for 2024, indexed for inflation) directly from your IRA to a qualified charity. The amount you donate counts towards your RMD for the year, but it is excluded from your taxable income. It’s a fantastic way to do good while also satisfying the IRS and lowering your tax bill.