What Is Mandatory Distribution?
Mandatory distribution refers to the minimum amount of money an individual must withdraw from certain types of tax-advantaged retirement accounts each year in order to avoid tax penalties. Mandatory distributions go into effect in the year an individual turns 72 years old. The Internal Revenue Service’s official name for mandatory distributions is required minimum distributions or RMDs.
On March 27, 2020, President Trump signed into law a $2 trillion coronavirus emergency stimulus package called the CARES (Coronavirus Aid, Relief, and Economic Security) Act. The CARES Act waives RMD payments for 2020, including those for inherited IRAs. The waiver also applies to initial RMDs, which individuals may have delayed from 2019 until April 1.
Previously, RMDs started at age 70½, but that changed to age 72 with the Dec. 2019 passage of the Setting Every Community Up For Retirement Enhancement (SECURE) Act.
- Mandatory distributions occur when an individual reaches the age required to take distributions. For 2020, that's age 72.
- The required minimum distributions for each account type are calculated differently.
- Excess withdrawals do not lower the required minimum distributions in future years.
How Mandatory Distributions Work
Mandatory distributions apply to traditional individual retirement accounts, 401(k)s, 403(b)s, 457(b)s, SEPs, SARSEPs, SIMPLE IRAs, and Roth 401(k)s. They do not apply to Roth IRAs during the owner’s lifetime.
Once the age trigger is reached, the person must take mandatory distributions by Dec. 31 each year. Otherwise, the IRS imposes stiff penalties: a tax of 50% on the amount that should have been withdrawn. Exceeding the mandatory distribution is allowed.
Of note, in the very first year of mandatory distributions, some retirees end up taking two years’ worth of distributions. This is because the IRS allows retirees to delay the first distribution until April 1 of the following year. This allows tax-advantaged investment returns to build up for a longer period of time.
The rules for mandatory distributions change if the retirement account in question is inherited. There is also a difference based on the beneficiary's relationship to the original account holder.
For a non-spouse, adult child, trust, or institution that inherits the account, the full account must be drawn down within 10 years. That's due to the SECURE Act. Previously, this kind of beneficiary could have taken RMDs throughout their lifetime.
If the beneficiary is a spouse, a child under 18, or someone with a disability, they do not have to draw down the account balance within 10 years. Instead, they have the option to take mandatory distributions over their entire lifetime, as long as they begin within one year of the original owner’s death.
Mandatory distribution amounts are based on the account balance and the account holder’s life expectancy, as determined by IRS tables. IRA custodians and plan administrators usually calculate RMDs for account holders, though technically, it is the account holder’s responsibility to determine the correct minimum distribution amount.
Workers who don't own more than 5% of the company they work for are permitted by the IRS to postpone taking mandatory distributions from retirement accounts associated with that job until April 1 of the year after they retire.
How to Calculate a Mandatory Distribution
The amount of mandatory distributions is calculated separately for each account type. For an IRA, for example, take the account balance as of the previous Dec. 31, then divide this by a so-called life-expectancy factor. The IRS includes these factors in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).
There are three different tables in the publication, based on different life situations. Choose the Joint and Last Survivor Table if you are the sole account beneficiary and are more than 10 years younger than your spouse. Choose the Uniform Lifeline Table if you have a spouse, but one who doesn't fit the definition given in the Joint and Last Survivor Table. Finally, choose the Single Life Expectancy Table if you are the beneficiary of an account or an inherited IRA.