- Required Minimum Distributions (RMDs) are withdrawals you must make each year from retirement accounts.
- RMDs usually start at age 72, but it can be helpful to accrue them much earlier.
- Not withdrawing enough to meet the RMDs can result in hefty tax penalties.
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Required Minimum Distributions (RMDs) are the minimum amounts that must be withdrawn each year from many types of retirement accounts. They generally apply to people aged 72 and over, although some exceptions may apply.
The money you withdraw as RMD is generally considered taxable income. So rather than letting your retirement account grow tax-free indefinitely while living off other sources of income, the IRS has rules in place that encourage you to withdraw at least some of your retirement funds. . If you don’t, you could be hit with even bigger tax penalties.
Because you’ll likely need to withdraw money from accounts like an Individual Retirement Account (IRA) or 401(k) eventually, it’s worth factoring this into your retirement planning well before you turn 70.
“If you don’t plan properly, you could end up with a much larger RMD than you need to meet your cash flow needs,” says Valerie Harman, tax and financial planner at Buckingham Advisors.
So rather than putting all of your savings into a retirement account that will have RMDs, you might want to put money into ones that don’t have those same restrictions.
“For example, Roth IRAs and non-qualified accounts should be part of most people’s retirement savings plans because these types of accounts don’t have RMDs, and they also offer the ability to manage your income. taxable,” adds Harman.
How is an RMD calculated?
Most types of retirement accounts have RMDs, including:
Incentive plans and other types of defined contribution plans are also generally subject to RMDs.
However, Roth IRAs do not have minimum withdrawal requirements for the life of the account holder, although certain rules apply to beneficiaries.
When it comes to calculating RMDs, the amount is not a fixed number or a percentage that always stays the same. Instead, an RMD is based on two factors:
- The account balance at the end of the previous year
- The distribution period, as determined by the Internal Revenue Service
To complete the calculation, simply divide the account balance by the distribution period. Distribution periods are tied to life expectancy, so when you start having to take RMDs at age 72, it will be higher. As you age, the distribution period decreases, which means that a greater proportion of your retirement account balance should be withdrawn.
These figures are available in the IRS Uniform Lifetime Table, which is the most commonly used standard calculation table. Of course, exceptions apply, such as for those who have a younger spouse over 10 years old and are the sole beneficiary of the retirement account in question.
For example, the Uniform Lifetime Table for 2022 shows that for someone who is 75, the distribution period is 24.6. So if a 75-year-old man wanted to calculate his RMD based on an IRA balance of $1 million, he would divide $1 million by 24.6, which equals $40,650.41. An 85-year-old would use a factor of 16, which would produce an RMD of $62,500 based on the same balance of $1 million.
The good news is that you don’t necessarily need to do the RMD calculations yourself.
“Usually your financial adviser, or perhaps the custodian with whom you hold this [retirement account] will calculate that RMD amount for you each year,” says Harman.
2022 Lifetime Uniform Table (up to age 95)
Source: Federal Register
When should I start receiving the required minimum distributions?
RMDs generally come into effect at age 72, although there are some important nuances to understand.
For one thing, you don’t have to take an RMD as soon as you turn 72. Instead, you have until April 1 of the following year from when you reach that age. After that, you must take your RMD by December 31 each year. This may mean that you take two RMDs in the first calendar year you start making these withdrawals.
Another important nuance is that for employer-sponsored plans, such as 401(k)s, you may be able to wait longer to take your RMDs. That’s because IRS rules apply no later than age 72 and the year you retire, assuming your plan allows you to keep your assets there. So it’s possible that if you’re still working after age 72, your employer-sponsored plan allows you to delay taking RMDs.
Also note that if you have more than one retirement account, you will need to calculate the RMD for each. But if you have multiple IRAs, then you can combine those RMD amounts into one sum and withdraw that money from one account. However, for many types of employer-sponsored plans, besides 403(b), you must withdraw RMDs from each account separately.
What happens if I don’t withdraw the required amount?
If you don’t withdraw enough to meet your RMD each year, you may have to pay an additional tax equal to 50% of the difference between what you withdrew and your RMD.
That said, there may be ways to avoid this penalty. For example, you can file Form 5329 and include an explanation of why a reasonable error was made and how you are correcting that error, in which case you may qualify for a waiver.
You may also be able to satisfy the RMD without putting the money in your own accounts if you wish to avoid increasing your taxable income. To do this, you could potentially make a qualified charitable distribution from an IRA, where your trustee distributes your RMD amount directly to a charity.
Not everyone has the financial capacity to donate their full RMD amount, but it is an option to consider as part of your tax and retirement planning. In general, accounting for those RMDs before you have to take them can go a long way to improving your finances.
“Start planning your RMDs early in life,” says Harman. “Like any type of planning, the sooner you develop a plan and start implementing it, the better your chance of success.”