Required Minimum Distribution (RMD): An Overview

The concept of retirement savings revolves around accumulating a nest egg over working years and then spending it during retirement. But did you know that the U.S. government mandates minimum withdrawals from certain types of retirement accounts once you reach a certain age? These are known as Required Minimum Distributions or RMDs.

Key Takeaways: Required Minimum Distribution (RMD)

• Definition: RMDs are mandatory annual withdrawals from certain retirement accounts starting at age 72 (or 70½ if older by 2020).
• Accounts Affected: Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k), 403(b), and 457(b) plans have RMD requirements.
• Roth Distinctions: Roth IRAs don’t have RMDs for the original owner, but Roth 401(k)s do.
• Calculation: RMD amounts depend on account balances and IRS’s Uniform Lifetime Table.
• Penalties: Not taking RMDs results in a significant 50% tax penalty on the amount not withdrawn.

What is a Required Minimum Distribution (RMD)?

RMD refers to the minimum amount that a retirement account holder must withdraw from their account each year once they reach a specified age. This age was traditionally 70½, but following the passage of the SECURE Act in December 2019, the age was raised to 72 for those who did not turn 70½ by the end of 2019.

Which Accounts Are Subject to RMDs?

RMD rules apply to the following tax-advantaged retirement accounts:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k), 403(b), and 457(b) plans

Notably, Roth IRAs are not subject to RMD rules while the owner is alive.

How is the RMD Calculated?

The RMD for each year is calculated by dividing the retirement account’s balance as of the end of the previous year by a distribution period from the IRS’s “Uniform Lifetime Table”. For most people, this table provides the distribution period based on the retiree’s age. There are other tables available for beneficiaries or for account holders whose spouses are more than ten years younger and are the sole beneficiaries.

Why Do RMDs Exist?

RMDs are a mechanism through which the federal government ensures that money in tax-advantaged retirement accounts, which has been growing tax-deferred, eventually gets taxed. Without RMDs, retirees could potentially hoard their retirement funds, passing them on to heirs without the funds ever being subject to income tax.

What Happens if You Don’t Take the RMD?

Failure to withdraw the RMD by the annual deadline results in a hefty penalty. The amount not withdrawn is taxed at a whopping 50%. This means that if you were required to withdraw $5,000 and didn’t, you could owe a $2,500 penalty.

Some Key Considerations

1. Timing: Your first RMD must be taken by April 1st of the year following the calendar year in which you turn 72 (or 70½ if you turned that age before 2020). Subsequent RMDs must be taken by December 31st of each year.
2. Roth 401(k)s: Unlike Roth IRAs, Roth 401(k)s are subject to RMDs. However, if one rolls over their Roth 401(k) to a Roth IRA, they can sidestep this requirement.
3. Multiple Accounts: If you have multiple retirement accounts, you must calculate the RMD for each account separately. However, if you have several IRAs, you can total the RMDs and take the combined amount from one or more of the IRAs.
4. Recent Changes: Always stay updated with legislative changes. Laws like the SECURE Act have adjusted RMD rules in the past.

Required Minimum Distributions (RMDs) for Different Retirement Accounts

Understanding the specifics of how RMDs apply to various retirement accounts is crucial for ensuring compliance and avoiding penalties. Here’s a breakdown of how RMDs pertain to each major type of retirement account:

1. Traditional IRAs:
   • RMDs are mandatory for all account holders, starting at age 72 (or 70½ if you turned that age before 2020).
   • The RMD amount is calculated based on the account balance at the end of the previous year and the distribution period from the IRS’s Uniform Lifetime Table.
2. SEP IRAs:
   • Just like Traditional IRAs, account holders must start taking RMDs at age 72 (or 70½ if you turned that age before 2020).
   • The RMD calculation is also similar to that of Traditional IRAs.
3. SIMPLE IRAs:
   • RMDs are also mandatory starting at age 72 (or 70½ if applicable).
   • The formula for RMD calculation aligns with the Traditional and SEP IRAs.
4. 401(k), 403(b), and 457(b) plans:
   • RMDs must be taken from these employer-sponsored plans beginning at age 72 (or 70½ if you turned that age before 2020), unless you’re still working and not a 5% owner of the company. If still employed, you can delay RMDs until you retire.
   • The RMD amount is derived using the same IRS Uniform Lifetime Table.
5. Roth 401(k):
   • Unlike Roth IRAs, Roth 401(k)s are subject to RMDs. Account holders must take RMDs starting at age 72, similar to traditional 401(k)s.
   • However, these distributions are generally tax-free, as contributions to Roth accounts are made with after-tax dollars. Still, earnings may be taxable if specific requirements aren’t met.
   • Transferring funds from a Roth 401(k) to a Roth IRA before the RMD age can be a strategy to avoid these distributions, as Roth IRAs are not subject to RMD rules for the original owner.
6. Roth IRAs:
   • Account holders are not required to take RMDs during their lifetime.
   • Beneficiaries, however, will have specific distribution requirements upon inheriting a Roth IRA.

Conclusion

While the concept of RMDs might seem straightforward, the specific requirements and calculations can get intricate. It’s always advisable to consult with a financial advisor or tax professional when determining your RMDs to ensure compliance and optimize your retirement financial planning.