If you have a traditional, SEP, inherited, Roth 401(k) or simple individual retirement account (IRA), then you need to understand the required minimum distribution or RMD. This is the amount of money that you must withdraw from your IRA by April 1 of the year after you reach age 70.5 and each subsequent year (by Dec. 31). The withdrawal amount is calculated by dividing the prior year-end market value of the account by your future life expectancy. (For related reading, see: Is My IRA Protected in a Bankruptcy?)
The RMD process is not as simple as it first appears. Although you may wait until April of the year after you turn age 70.5 to take your RMD, if you do so, you’ll need to take the next year's RMD by Dec. 31. (The inherited IRA may have some differences from the other IRAs.)
If you fail to comply with the RMD rules, be ready to pay penalties.
How to Calculate Correctly
1. List the fair market value of all of your IRAs separately as of Dec. 31 of the previous year.
3. After you’ve figured out the RMD for each IRA account, in most cases, you may withdraw the distribution from several IRA accounts or one. Just know that RMDs from 457(b) and 401(k) plans must be taken from each of their respective accounts.
4. To avoid RMD tax hits, pay the taxes due on the withdrawal promptly. If you choose to withdraw more than the minimum, then make certain to pay the tax owed on the total withdrawal amount. Be aware that even if you withdraw more than the RMD in one year, the excess amount will not count towards the withdrawal amount for the subsequent year. That’s because your subsequent year’s withdrawal is based upon the end of the prior year value of the account. (For related reading, see: The Basics of Roth IRA Contribution Rules.)
The IRS requires your brokerage company to automatically withhold 10% of any RMD for federal income taxes. To avoid penalties, make estimated tax payments to the federal, state, and local tax authorities. The federal government considers your RMD as ordinary income which is taxed at your personal federal income tax rate. If you underpay your taxes, then you may be subject to an additional tax penalty.
There’s a huge incentive to correctly calculate your RMD and pay the appropriate taxes on time. If you don’t withdraw the total RMD on time from your IRA, not only will you be liable for the taxes, but you’ll also incur a 50% penalty on the insufficient or late RMD withdrawal.
If you do not withdraw the full amount of the RMD by the deadline and you incur the 50% penalty, you must file IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, with your federal tax return for the year you don't pay the full RMD.
The penalty for inaccurate or insufficient RMD withdrawals is dire, and the so are the tax consequences. Don't try to get cute and roll over the RMD into another tax-deferred account; that's not allowed by the IRS.
The Bottom Line
As you approach age 70, consult your financial advisor, IRS.gov, and other reputable resources to understand your IRA required minimum distributions. To avoid the hefty tax and penalties of late or insufficient RMD withdrawals, educate yourself and pay the projected tax bills on time. Finally, if you have a Roth IRA, there are no RMDs. (For related reading, see: 6 Reasons Not to Convert Your Roth IRA.)