What Is a Required Minimum Distribution (RMD)?
A required minimum distribution (RMD) is the amount of money that must be withdrawn from an employer-sponsored retirement plan, traditional IRA, SEP, or SIMPLE individual retirement account (IRA) by owners and qualified retirement plan participants of retirement age.
In 2020, the age for withdrawing from retirement accounts changed from 70½ to 72 years old. You must therefore begin withdrawing from a retirement account by April 1 following the year account holders reach age 72. The retiree must then withdraw the RMD amount each subsequent year based on the current RMD calculation.
- The required minimum distribution is the amount you must take out of your account to avoid tax consequences.
- Retirees can and do take more than the RMD.
- If you have multiple accounts, you will usually need to calculate the RMD for each separately and may have to take an RMD from each.
- The SECURE Act of 2019 changed the distribution rules for some inherited IRAs, effectively eliminating the "stretch IRA"—an estate planning strategy that extended the tax-deferral benefits of IRAs.
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Understanding Required Minimum Distributions (RMDs)
A required minimum distribution (RMD) acts as a safeguard against people using a retirement account to avoid paying taxes. Required minimum distributions are determined by dividing the retirement account’s prior year-end fair market value (FMV) by the applicable distribution period or life expectancy. The Internal Revenue Service (IRS) has a worksheet to help taxpayers calculate the amount they must withdraw. Generally, your account custodian or plan administrator will calculate these amounts and report them to the IRS.
Some qualified plans allow certain participants to defer the start of their RMDs until they actually retire, even if they are older than age 72. Qualified plan participants should check with their employers to determine whether they are eligible for this deferral.
It should be noted that while an account holder must withdraw the required minimum distribution amount, they can also withdraw above that amount. If the account holder wants to withdraw 100% of the account in the first year, that’s perfectly legal, but the tax bill could be a shocker.
The RMD rules do not apply to Roth IRAs while the owner is still alive. However, the RMD rules do apply to Roth 401(k) accounts.
How to Calculate Required Minimum Distributions
When calculating a required minimum distribution for any given year, it is always wise to confirm on the IRS website that you are using the latest calculation worksheets. These tables are updated to reflect changes in life expectancy.
Different situations call for different calculation tables. For example, IRA account holders whose spouse is the account’s only beneficiary and more than 10 years younger than the account holder use a different table than other account holders.
For traditional IRA account holders, the RMD calculation involves three steps:
- Write down the account’s balance as of Dec. 31 of the previous year.
- Find the distribution factor listed on the calculation tables that corresponds to your age on your birthday of the current year. For most people, this factor number ranges from 27.4 all the way down to 1.9. As a person gets older, the factor number goes down.
- Divide the account balance by the factor number to find the RMD.
Example of a Required Minimum Distribution
For example, we have Bob, an account holder age 74, whose birthday is on Oct. 1. April is nearing, and Bob’s IRA is worth $225,000 and had a balance of $205,000 on Dec. 31 of the previous year. The distribution factors from the relevant IRS table are 23.8 for age 74 and 22.9 for age 75.
The required minimum distribution is calculated as:
RMD = $205,000 ÷ 22.9 = $8,951.97
So Bob needs to withdraw at least $8,951.97.
There are some other things Bob should keep in mind. Let's suppose Bob has multiple IRAs. This means the RMD must be calculated separately for each account. Depending on the types of accounts involved in this scenario, Bob may have to take RMDs separately from each account rather than all from one account.
Special Case: Inherited IRAs
If you inherit an IRA, for the year of the account owner's death, you will need to use the same RMD the account owner would have used. However, for years following the account owner's death, your RMD depends on your identity as the designated beneficiary. For example, RMD rules may vary depending on whether you are a surviving spouse, a minor child, or a disabled individual.
Generally, if you inherit an IRA from an account owner who died prior to Jan. 1, 2020, you would calculate your RMD using the IRS Single Life Table. However, if the account owner died after Dec. 31, 2019, you'll need to follow the RMD rules established by the SECURE Act, which distinguishes between eligible designated beneficiaries, designated beneficiaries, and non-designated beneficiaries. The timeframe and calculation of your RMD can vary greatly depending on which of these categories you belong to as a beneficiary.
For example, some designated beneficiaries may be required to withdraw the entire account by the 10th calendar year following the year of the IRA owner’s post-2019 death. Meanwhile, some non-designated beneficiaries may be required to withdraw the entire account within five years of the IRA owner’s death. These rules effectively eliminate the stretch IRA, an estate planning strategy that some beneficiaries of inherited IRAs had used in the past to extend the tax-deferred benefits of an IRA.
As RMD rules can be complex, it's important to review IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), when making decisions regarding your distributions from an inherited IRA.
When Do RMDs Start?
At present, individuals must start taking required minimum distributions from qualified retirement accounts at age 72. Prior to the year 2020, the RMD age was 70½.
Are RMD Distributions Taxed?
Yes, because RMDs are withdrawn from retirement accounts that had contributions made with pre-tax dollars, there exists a deferred tax liability. Income tax must therefore be paid on RMDs when they are taken (at your current tax bracket). The exception would be RMDs taken from a Roth 401(k), which is tax-exempt.
What If I Don't Take RMDs?
If you are over age 72 and choose not to take your RMD, you will be penalized by the IRS. In particular, the amount not withdrawn will be subject to a 50% tax.
Why Does the IRS Impose RMDs?
Because traditional IRAs and 401(k) plans use pre-tax dollars, the IRS imposes RMDs to prevent individuals from avoiding paying the deferred tax liability owed on those contributions.