Required Minimum Distribution (RMD)
Point of Interest:
You must begin to take required minimum distributions from your pre-tax retirement accounts once you reach 72, or else face hefty IRS penalties.
As we save and invest for retirement, we can tuck money away in pre-tax accounts, like a 401(k) or a SEP IRA. Pre-tax accounts allow your money to grow over the years, or decades, without the government touching it either before or after it hits the account. You pay taxes only when you withdraw the money later in life.
This is great news for your investment growth rate, and can be a helpful tool in building yourself a secure retirement nest egg. However, the government does want to make sure that you pay taxes at some point. That’s why there are required minimum distributions for those accounts.
What is required minimum distribution?
For some retirement accounts, you don’t pay taxes in the year you make your contributions. Instead, you pay taxes on the withdrawal. These are called pre-tax accounts. Accounts that fall into this category are Traditional IRAs, SIMPLE IRAs, SEP IRAs, 457bs, profit-sharing plans, 401(k)s or 403(b)s, and any other defined contribution plans.
The government requires that you take what is called “required minimum distributions” from your pre-tax retirement accounts starting at age 72, or 70 1/2 if you turned 70 1/2 before January 1, 2020.
You must begin to take required minimum distributions from your pre-tax accounts once you reach 72. For those who are decades or years away from RMDs, focus your energy on investing as much as you can. For those coming up to age 72 more quickly, it’s time to do a thorough review of your entire financial picture.
The government requires RMDs to ensure that participants in these plans pay their taxes. Since you only pay taxes on withdrawal, if you never withdrew any money, you would never pay taxes. RMDs get around that by forcing you to take money out.
You can also take out more than the minimum required. RMDs are only a baseline. If your spending needs are more than that baseline, you can withdraw more money.
How do you calculate a required minimum distribution?
There isn’t one standard, universal required minimum distribution that everyone must take out. Rather, what your specific RMD will be is based on how much money you have in your accounts.
Here’s the formula: The total account balance (take each account individually) from the end of the previous year and divide by the IRS determined life expectancy, as defined by the Uniform Lifetime Table.
The Uniform Lifetime Table is designed by the IRS to generally predict how long you will live and thus how much money you can withdraw from your accounts.
There are different regulations around RMDs for different types of accounts, and how much you need to take out will depend on how much is in each account. The table helps you determine what your required minimum distributions should be.
The IRS supplies worksheets from its website to help you calculate your required minimum distribution. There is one specifically for if your spouse is your sole beneficiary of your IRA and is also more than 10 years younger than you. The other worksheet is for every other situation.
(RMDs for inherited IRAs have to be calculated separately, and the RMD can only be withdrawn from their respective accounts.)
From here, you can calculate what your RMD will be based on what you currently have in the account (for those that are a year or less away from taking one.) The number will change a little due to market fluctuation, but this should give you an idea of what your withdrawal will look like. From there, you’ll be able to better shape your retirement spending plan.
Who is required to follow the required minimum distribution?
Starting in 2020, anyone over 72 with an appropriate account is required to make an RMD. This is a change from previous years, when the age was 70 1/2 years old.
If you do not take any distributions, or if you don’t take big enough distributions, the IRS may collect a 50% excise tax on the amount not distributed. If you were supposed to withdrawl $10,000 and didn’t, the IRS could levy that 50% excise tax on that $10,000.
Examples of a required minimum distribution
For your IRA accounts (including SIMPLE and SEP) you must take an RMD by “April 1 of the year following the calendar year in which you reach age 72 (or 70 1/2 if you turned age 70 ½ before January 1, 2020)” according to the IRS website.
For your 401(k), profit-sharing, 403(b), or other defined contribution plan, you must take an RMD by April 1 following the calendar year in which you reach age 72 (or 70 ½ if you turned age 70 ½ before January 1, 2020), or retire from work.
If John is 72 by April 15, 2019, he is going to be required to take an RMD by April 1st, 2020. To figure out what his RMD is, he will use what his Traditional IRA total balance was on December 31, 2019.
Say the total is $500,000. At 72, his life expectancy is 25.6 years according to the IRS.
John would divide his $500,00 by 25.6 to come up with his RMD, which would be $19,531.25.
Retirement accounts that are an exception to RMD
You do not have to take a required minimum distribution from a Roth IRA or any Roth form of a retirement account. (For example, you can have a Roth 401(k) account.) Since you pay the taxes on a Roth style account upfront, you are not required to make RMDs later in life.