What Is a Required Minimum Distribution (RMD)?
As of 2020, participants must begin withdrawing from their retirement accounts by April 1 following the year they reach age 72 (prior to 2020, the RMD age had been 70.5 years old). The retiree must then withdraw the RMD amount each subsequent year based on the current RMD calculation.
- The required minimum distribution is the amount a person must take out of their 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.
Understanding Required Minimum Distribution (RMD)
An 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 by the applicable distribution period or life expectancy. The IRS has a worksheet to help taxpayers calculate the amount they must withdraw.
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 an investor must withdraw the required minimum distribution but may withdraw above that amount. If an investor wants to withdraw 100% of the account in the first year, that's perfectly legal, but the tax bill could be a shocker.
How to Calculate a Required Minimum Distribution (RMD)
When calculating a required minimum distribution for any given year, it is always wise to confirm on the Internal Revenue Services website that you are using the latest calculation worksheets.
Different situations call for different calculation tables. For example, IRA account holders whose spouse is the account's only beneficiary and is more than 10 years younger than the account holder use one table, while IRA account holders whose spouse is the account's only beneficiary and the same age as the account holder use a different table.
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 (RMD)
For example, we have Bob, who is an account holder age 74, and his birthday is October 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 his 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. If, for example, he has multiple IRAs (lucky Bob) he must calculate the RMD separately for each account. Depending on the types of accounts Bob has, he may have to take RMDs separately from each account as well rather than all from one account.
Special Case: Inherited IRAs
Generally, with an inherited IRA, an account holder must take annual distributions regardless of age. Failure to take the distribution results in a whopping 50% tax penalty on the RMD. Spouses and non-spouses are treated differently here, so it is important to check the IRS guidelines on inherited IRAs.