What Are Required Minimum Distributions or RMD’s?
Required Minimum Distributions (RMDs) can feel like a complex and imposing topic, but they play an essential role in retirement planning. The rules surrounding RMDs are important for anyone with a tax-deferred retirement account, as understanding them can help you manage your income, reduce tax burdens, and ensure compliance with IRS regulations. This guide will help clarify what RMDs are, why they matter, and how you can navigate them effectively.
What are Required Minimum Distributions (RMDs)
RMDs are the minimum amounts that you must withdraw annually from your tax-deferred retirement accounts once you reach a certain age. These accounts include Traditional IRAs, SEP IRAs, SIMPLE IRAs, and most employer-sponsored retirement plans like 401(k)s. It’s important to clarify that RMD’s generally affect Pre-Tax savings and not Tax-Free or Roth Savings. So, your Roth IRA, Roth 401k, and Roth 403b funds will not be subject to RMD’s.
The purpose of RMDs is simple: the government allowed you to defer taxes on these accounts for decades, and now it’s time to pay the tax as you withdraw the funds. When you withdraw money from a Pre-Tax Account, you are generally taxed on the distribution.
See Understanding Tax Implications for Investment Accounts – Gilbert Wealth
When do RMD's Begin and How Much Will They Be?
When RMD's Begin
When RMD’s begin depends on your age. While they used to begin at age 70 1/2 for everyone, The SECURE Act 2.0 increased the ages for different retirees:
| Birth Year | Age RMDs Begin |
|---|---|
|
1950 or Earlier |
72 (70 1/2 for those who turned 70 1/2 before 2020) |
|
1951 to 1959 |
73 |
|
1960 or Later |
75 |
How Much RMD's Will Be
The amount of the RMD will vary from year to year because it is based on the previous year end value of the applicable accounts and your life expectancy as determined by an IRS table.
Most Life Expectancies use the IRS Uniform Lifetime Table but there are other tables depending on the age of your spouse. The Uniform Lifetime Table is recreated below from the IRS website.
For example, if your year-end account balance was $100,000 and you are 80 years old, you would calculate your RMD as follows:
RMD = $100,000 divided by 20.2 = $4,950.50
Additional Rules about RMD's
Missed RMD Penalty
If a Required Minimum Distribution (RMD) is not taken on time, the IRS imposes a penalty on the shortfall. As of 2023, the penalty is 25% of the amount not withdrawn, but it can be reduced to 10% if the mistake is corrected promptly by submitting Form 5329 and taking the missed distribution. This penalty applies to each missed RMD and can significantly increase taxable liability. Ensuring timely RMDs is essential to avoid these penalties, as well as potential impacts on income taxes, Social Security benefits, and Medicare premiums.
Ordering Rule
When subject to RMDs, any distribution taken from the applicable account is deemed to first be part of the RMD. This is important as you can no longer convert these amounts to Roth.
Aggregation Rule
The Aggregation Rule determines how and where you are able to take RMDs. This rule separate accounts into different groups for the purpose of distributions.
Traditional IRAs, SEP IRAs, and SIMPLE IRAs:
- RMDs must be calculated separately for each IRA account.
- However, the total RMD amount for all IRAs can be taken from one or multiple IRA accounts at the owner’s discretion.
- This allows for flexibility in managing withdrawals to minimize tax impact or preserve certain investments.
401(k), 403(b), 457(b), and other qualified plans:
- RMDs must be calculated and taken separately from each employer plan.
- Unlike IRAs, RMDs cannot be aggregated across different employer plans.
- Each plan administrator will notify the account holder of the required RMD and facilitate the withdrawal from the respective plan.
- Inherited IRA’s have their own RMD requirements separate from all other accounts.
What You Can Do with an RMD
RMDs have to exit the IRA structure entirely. They cannot be rolled into another Traditional IRA, 401k, or Roth IRA. Here is a brief list of options:
- Transfer it to you bank to spend it.
- Transfer it to a taxable investment account and reinvest it.
- Donate it to charity using Qualified Charitable Distributions. See The Win-Win Strategy: QCDs and Charitable Contributions – Gilbert Wealth