Minimum distributions are a crucial part of your retirement planning if you use a retirement account. Employer-sponsored retirement plans, IRAs, Simple IRAs, and SEP IRAs are typically subject to this amount.
What Is a Required Minimum Distribution (RMD)?
A required minimum distribution, or RMD, is the minimum amount you must withdraw annually from your traditional IRAs or employer-sponsored retirement account once you're 72.
However, you can withdraw more than the minimum amount required per IRS regulations. In addition, it's perfectly legal to remove the entire amount, although that could attract exorbitant taxes.
If you have multiple tax-deferred retirement accounts, you'll have to calculate the RMDs for each account separately and withdraw the required minimum from each account.
Any withdrawals will be part of your taxable income unless it is tax-exempt or you've paid your taxes. Typically, withdrawals from your Roth IRA will not suffer any tax penalties since your deposits are taxable.
Understanding RMDs
People with traditional or employer-sponsored retirement accounts can withdraw the required minimum distribution.
Account Types
You need to withdraw RMDs from tax-deferred retirement accounts, including:
- Most 401(k) and 403(b) plans
- Traditional IRAs
- Simple and rollover IRAs
- SEP IRAs
No required minimum distribution needs to be withdrawn from Roth IRAs unless they are inherited.
Your Plan's Terms
You must begin withdrawing RMDs from your tax-deferred retirement accounts after reaching 72, even when you are still employed.
You can calculate the RMD by dividing the account balance in the previous year by a life expectancy factor as provided by the IRS in their worksheet.
Your retirement plan administrator or the custodian of your accounts is responsible for calculating the amount and reporting it back to the IRS.
Beginning Date of Your First RMD
For traditional IRAs, including Simple IRAs and SEP, RMD will begin on April 1st, following the year you reach 72 years.
For 401(k), 403(b), profit sharing, or any other defined contribution plan, RMD will begin on April 1st, following the year you reach 72 or retire.
Penalties
Once you are 72, you must make withdrawals based on your retirement account's RMD. If you fail to make a withdrawal or meet the required amount, you'll have to pay a 50% excise tax on the amount not withdrawn.
However, specific qualified plans allow account holders to withdraw RMDs when they retire, even at an age later than 72 years. You need to check with your employer if you are qualified for the deferred RMD payment.
Calculating an RMD
To calculate the RMD, you need to follow the worksheet provided by the IRS on their website. In addition, there are Lifetime Expectancy Tables in Appendix B of IRS Publication 590, which you'll need to access to find the correct withdrawal factor for the RMD calculation.
There are different calculation tables for other retirement accounts. Follow the one that is relevant to you.
For instance, if you are a traditional IRA account holder, you need to calculate RMD in the following way.
- Locate your account balance on December 31st of the previous year.
- Determine your age at the end of the year.
- Find your withdrawal factor from IRS Pub. 590 appropriate Lifetime Expectancy Table.
- Divide your account balance by the life expectancy factor number to determine the RMD.
Example:
- Your account balance is $205,000.
- You'll be 74 by the end of the year.
- You're married to a spouse who's not ten years younger.
Next, you'll need to look at the IRS Table III: Uniform Lifetime to determine your life expectancy factor of 25.5.
To calculate the RMD of your account, you'll need to divide your funds by the life expectancy factor, which will lead to $8,039.22.
In addition, the timing of the withdrawal, death of the account holder, beneficiary age, and changes in marital status will affect your required minimum distribution. Therefore, your results may increase or decrease based on changes to these factors.
Calculating RMDs After the Death of the Account Holder
On the account holder's death, the RMD due is the amount to be withdrawn by the account holder if he was alive. From the year following the account holder's death, RMD will depend on the characteristics of the designated beneficiary of the account holder.
Takeaway
RMD can be a great strategic tool for your retirement income. It can reduce your taxes while increasing the options for reinvestment in the future.