The amount 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 70 ½ years old. The Internal Revenue Service’s (IRS) official name for mandatory distributions is “required minimum distributions,” or RMDs.
Mandatory distributions apply to traditional IRAs, 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. You must take mandatory distributions by December 31 each year. If you don’t, the IRS imposes stiff penalties: a tax of 50% on the amount that should have been withdrawn. A mandatory distribution is a minimum; you can withdraw more if you wish. However, you can’t carry over any excess withdrawals to reduce your RMDs in future years.
When you take mandatory distributions, you pay tax on them at your current marginal tax rate. In the first year that you’re required to take mandatory distributions, you may end up taking two years’ worth of distributions because you can delay the first distribution until April 1 of the following year. Doing so means continuing to earn tax-advantaged investment returns for longer, but might put you in a higher tax bracket and mean that you’ll pay a higher marginal tax rate on the portion of your distribution that pushes you into that bracket.
The rules for mandatory distributions change if the retirement account in question is inherited. Instead of waiting until age 70 ½, the account’s beneficiary has two options. He or she can withdraw the entire account balance within five years of the owner’s death, or the beneficiary can take mandatory distributions over his or her entire lifetime as long as they begin within one year of the 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.
If you keep working past age 70 ½ and do not own more than 5% of the company you work for, you may be allowed to postpone taking mandatory distributions from the retirement account associated with that job until April 1 of the year after you retire from that job.