What is the 'Required Minimum Distribution Method'

The required minimum distribution method forms the basis for calculating the amount of money the IRS requires retirees to withdraw from their retirement accounts as they age.

BREAKING DOWN 'Required Minimum Distribution Method'

The required minimum distribution method provides an age-based calculation of the amount retirees must withdraw from their accounts each year to deplete their savings within their actuarially expected lifetime. Retirees must withdraw at least this amount from their account each year to avoid adverse tax consequences.

The IRS ensures individuals do not hold tax-advantaged funds in qualified accounts indefinitely by requiring that they withdraw a certain minimum amount of money from their accounts. Under most circumstances, the IRS sets the required beginning date (RBD) on which account holders must begin to take distributions at April 1 following the calendar year in which the account holder turns 70.5.

The IRS calculates the required minimum distribution by establishing a distribution period related to the retiree’s actuarial life expectancy. To arrive at the distribution amount, the individual takes the balance reported in the retirement account on December 31 of the previous year and divides it by the distribution period. The result equals the minimum amount the retiree must withdraw over the course of the current year to avoid penalties.

When retirees take less than the required minimum distribution, the IRS applies a 50-percent excise tax to the difference between the required minimum distribution and the actual amount withdrawn.

Example of a Required Minimum Distribution Calculation

Consider a 73-year-old retiree with a year-end balance of $500,000 in an IRA and suppose the current uniform lifetime table issued by the IRS produced a distribution period of 25 years. To arrive at the required minimum distribution for the current year, the retiree would divide $500,000 by 25, yielding a minimum distribution of $20,000. The IRS does not penalize retirees who withdraw more than their required minimum distribution. The nature of the calculation also means that required minimum distributions change year to year as the reduced life expectancy of the retiree causes the denominator to decrease. Any fluctuations in the account balance due to withdrawals or investment gains or losses would change the numerator in the calculation.

Use in SEPP Plans

For those younger than 59.5 years of age, the IRS provides an option to take distributions from retirement funds while avoiding early withdrawal penalties by placing funds in a substantially equal periodic payment (SEPP) plan. These plans require account holders to choose a method for calculating the amounts they may withdraw penalty free. Under this scenario, the required minimum distribution method provides a variable annual withdrawal amount based upon fluctuations in the account and the account holder’s life expectancy. Account holders may also choose fixed amortization and fixed annuitization methods to determine their allowable amount of penalty-free withdrawals prior to retirement.

  1. Rule 72(t)

    Rule 72 (t), issued by the Internal Revenue Service, allows for ...
  2. Four Percent Rule

    The 4 percent rule is one way for retirees to determine the amount ...
  3. Account Minimum

    Account minimum is the minimum balance required to maintain an ...
  4. Life Expectancy Method

    A life expectancy method calculates IRA payments by dividing ...
  5. Distribution Yield

    A distribution yield is a measurement of cash flow paid by an ...
  6. Annuity Factor Method

    The annuity factor method is a way to determine how much money ...
Related Articles
  1. Financial Advisor

    How to Save Clients from RMD Aggregation Mistakes

    Advisors can help clients avoid required minimum distribution mistakes in their retirement plans.
  2. Financial Advisor

    Stretch Your Savings By Working Into Your 70s

    Staying employed a little longer may allow for a more comfortable retirement.
  3. Retirement

    Multiple Accounts? Here's How to Calculate RMDs

    Ever wondered how to calculate required minimum distributions from multiple accounts? Here's a quick primer.
  4. Retirement

    How a 401(k) Works After Retirement

    Find out how your 401(k) works after you retire, including when you are required to begin taking distributions and the tax impact of your withdrawals.
  5. Retirement

    9 Penalty-Free IRA Withdrawals

    If you need to take early distributions, find out which exemptions allow you to avoid expensive consequences.
  6. Retirement

    Don't Forget To Take Minimum Distributions

    Take the right required minimum distributions from IRAs, 401(k)s and the like, starting the year you reach age 70 ½. There's a huge 50% penalty for being wrong.
  7. Retirement

    How You Withdraw Your Retirement Assets Matters

    Withdrawing your retirement income in the right order can help you make the most of what you have saved.
  8. Retirement

    Top Tips to Reduce Required Minimum Distributions

    A look at the best strategies to reduce required minimum distributions from qualified retirement accounts.
Hot Definitions
  1. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are considered socially conscious because of the nature of the ...
  2. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  3. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  5. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  6. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
Trading Center