What Is Mandatory Distribution?
Mandatory distribution refers to the minimum 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 72 years old. The Internal Revenue Service’s official name for mandatory distributions is required minimum distributions or RMDs.
Previously RMDs were 70-1/2, but that changed to 72 with the December 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.
- The required distributions for each account and account type are calculated differently.
- Excess withdrawals do not reduce 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 December 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 Otherwise, the IRS imposes stiff penalties: a tax of 50% on the amount that should have been withdrawn.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 ended 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 disabled, they do not have to draw down the account balance within ten years. They have the option of taking mandatory distributions over their 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.
Workers that do not own more than 5% of the company for which they work have the OK from 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. For an IRA, for example, take the account balance as of the previous December 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 a spouse is the sole account beneficiary, and this beneficiary is more than 10 years younger than the other marriage partner. Choose the Uniform Lifeline Table if you have a spouse, but one that does not 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.