Doing Required Minimum Distributions (RMDs) Right

The process for taking required minimum distributions from an IRA account is complicated. It's important to review the rules and deadlines for required minimum distributions because making mistakes is costly—if you miss taking one, or take out less than what is required, you will pay a 50% penalty. 

Why You Have to Take Required Minimum Distributions

In most cases, you have never paid tax on contributions to your employer's retirement plans (401(k), 403(b) and 457 plans) or traditional IRA accounts. In addition, you have never paid taxes on the earnings in these accounts. That's one of the great advantages of these plans. However, any money taken out of these retirement accounts is added to your income and taxed at that year's calculated tax rate. If allowed, many investors would prefer to keep their money in these accounts forever to avoid paying taxes. However, the IRS is not going to let that happen. The result: required minimum distributions (RMDs).

When RMDs Must Start

RMDs must start the year following the year you turn 70.5. For example, if you were born between July 1, 1946, and June 30, 1947, you turned 70.5 in 2017 and were required to take your first distribution from your traditional IRA accounts that year. In general, you need to take RMDs by December 31 of the year they are due. The exception to that rule is the first distribution. The IRS allows you to delay that first distribution until April 1 of the year following the year you turn age 70.5. If your birthday fell within the dates mentioned above, you could delay your first distribution until April 1, 2018.

Unfortunately, if you decided to delay, you would be required to take two distributions in 2018. Remember, the rule says you can only delay taking your first distribution. After that, all RMDs are due by December 31 of the year they are due. Since you would have an RMD due for 2018, it would have to be taken by December 31, 2018. The result: Both your 2017 and 2018 RMDs come out in 2018. Is that a bad thing? It depends. Taking both in one year means you have a higher tax bill, which you may not want. (For related reading, see: Preparing for Retirement Plan RMD Season.)

What Determines the Amount Distributed

Three things determine your RMD:

  1. Age: In our example above, those born in 1946 are 71 by December 31, 2017. Those born in 1947 should use age 70.
  2. Life expectancy: This is determined using the IRS Uniform Life Expectancy table
  3. IRA account balance: This is the balance on December 31 of the year before you turn 70.5. In our example, that's the balance on December 31, 2016.

The IRS publishes an RMD worksheet to help you calculate what you need to withdraw. If you are 71 on December 31, 2017, the IRS says your distribution period is 26.5 years. Assuming an account balance of $100,000 on December 31, 2016, your RMD is $3,773.58 ($100,000 divided by 26.5). If you are married and your spouse is 10 years younger than you, use the IRS joint life expectancy table found in IRS Publication 590-b to get your factor.

Taking Your RMD

Once you know your RMD amount, the next decision is how and when to take it. If it's your first, decide whether to take it the year you reach age 70.5 or by April 1 of the following year. Remember, you pay taxes based on the year money is withdrawn so by delaying, you would take two distributions in one year and pay taxes on both in a single year. If you have more than one IRA, calculate each one separately. (For related reading, see: Best Ways to Avoid RMD Tax Hits on IRAs.)

Once calculated, you have two choices on how to take them:

  1. Take the calculated RMD from each account separately
  2. Aggregate all RMDs and take the total from one account (This option is only available for IRAs).

If you are no longer working and have more than one employer retirement plan, you must calculate and take RMDs from each account separately. The penalty for missing your RMD or not taking enough is 50% of the amount you should have taken less the amount withdrawn. For example, if your RMD was $20,000 and you only took out $10,000, you would be required to take out the $10,000 (and pay taxes on it), plus pay a penalty of $5,000 (50% of $10,000). Obviously, you don't want that to happen.

Keep as Much Retirement Income as Possible

You have worked hard to save money in your employer-sponsored plan and/or traditional IRA for retirement; avoid paying more to the government than necessary by taking timely RMDs for the correct amount each year.

(For more from this author, see: 3 Reasons to Still Consider a Roth IRA Conversion.)