All tax-advantaged retirement accounts have rules for something known as the Required Minimum Distribution. Basically, these rules are in place to ensure that you take at least a minimal amount of money in withdrawals from your retirement accounts once you reach a certain age.
For many people, the Required Minimum Distribution will never be an issue because they will be withdrawing more than their RMD from their retirement accounts. But if you meet certain criteria, you’ll have to know your account’s RMD rules and regulations.
What Is the Required Minimum Distribution?
According to the IRS, Required Minimum Distributions are the minimum amount that a retirement account owner has to withdraw each year starting at the age of 70 1/2 or upon retirement, whichever is later. For IRA accounts, however, the RMDs must begin once the account holder is age 70, regardless of whether he or she is retired.
The RMD rules are in place for all employer-sponsored retirement plans, including profit-sharing plans, 401(k)s, 403(b)s, and 457(b)s. RMDs are also required for traditional IRAs, as well as SEPs, SARSEPs, SIMPLE IRAs, and Roth 401(k) plans.
One plan that’s exempt from RMD rules is the Roth IRA. You can choose not to take any distributions from a Roth IRA during your lifetime. When you die, the beneficiary for your Roth IRA will be required to take minimum distributions from the account.
Why are there RMD Rules?
US News and World Report points out that RMD rules are in place to ensure that the government can collect taxes on your retirement savings in a timely manner. Because withdrawals on most accounts are taxed, the government wants to be able to collect some of those taxes before your death.
This is why the Roth IRA plan escapes RMD rules for retirees. The money in your Roth IRA account has been taxed and won’t be taxed again on withdrawal. So the IRS doesn’t care if you take distributions from a Roth IRA or not.
When Does it Matter for You?
As with all things IRS-related, rules for the Required Minimum Distribution are complex.
Most of us will have to take the RMD on April 1 of the calendar year after which we reach 70 1/2 years old.
So if you turn 70 on May 15, 2013, you'll turn 70 1/2 on Nov. 15, 2013. So you'll have to take your first RMD by April 1, 2014.
However, this can become confusing if your half-birthday falls at the beginning of the year. For instance, if you turn 70 1/2 on Jan. 15, 2013, you don’t have to take your first RMD until April 1, 2014, the calendar year after you turn 70 1/2.
Here are some other rules you should know about:
- You must take the RMD from all (non-Roth) IRA plans, whether you’re retired or not.
- For 401(k), profit-sharing, 403(b), and other employer-sponsored, defined-contribution plans, the plan terms vary. For some plans, you can wait past the age of 70 1/2 to take RMDsif you’re still working. For others, you’ll have to take distributions based on your age, even if you’re still working.
- If you own 5 percent or more of the business sponsoring the retirement plan, you have to follow the age rules, regardless of whether you've retired.
- Once you start taking the RMD, you must withdraw your annual required minimum amount by Dec. 31 of each year.
- If the retirement account owner dies, the beneficiary will generally need to use the RMD the account owner would have received in the year he or she died. For the years following the account owner’s death, the RMD will vary depending on who the beneficiary is.
As you can see, the rules can get a little confusing, especially if you have multiple types of retirement accounts. This helpful chart from the IRS may help clear up some confusion about RMD rules for different types of accounts.
If you have questions, talk with your investment adviser and, perhaps, a tax professional to ensure you meet the legal requirements.
How to Calculate Your Required Minimum Distribution
Your RMD will change depending on your age since RMD calculations are based on life expectancy. The older you are, the more you’ll be required to withdraw from your account.
The IRS offers RMD worksheets that can walk you through some of the processes on paper. One is for basic RMD calculations. The other is what you should use if your spouse is at least 10 years younger than you and is the sole beneficiary of your retirement accounts. In this case, your spouse’s longer life expectancy will be used to reduce your RMD, so that the money in your retirement accounts will last longer.
Another option is to use an online calculator. Or you can talk to your investment company, as most companies will calculate your RMD for you.
Be Smart with Your RMD
Any time you’re talking about retirement withdrawals, it’s important to have a plan. It’s no different when you’re considering Required Minimum Distributions. Even though they’re required, having a solid strategy for when and how to withdraw them can help you stretch your retirement dollars.
Here are some smart strategies for taking your RMD, including:
- Understanding the rules. Failing to take RMDs when you’re supposed to results in penalties of 50 percent tax in addition to regular income tax on the money you should have withdrawn. You might think you’re saving yourself money skirting these laws, but you aren’t.
- Take your first distribution early. If you delay your first RMD until April 1, you’ll have to take both that one and a second RMD by Dec. 31, because they’re technically earmarked for different tax years. Since both withdrawals would count toward your income for the year, they could push you into a higher tax bracket. It’s better, much of the time, to take your first withdrawal earlier, so you pay taxes on it separately.
- Delay if you can. If you’re allowed to delay withdrawals because you’re still working, do it. You’ll save more money and gain more interest as long as you aren’t withdrawing.
- Combine withdrawals from your worst-performing account. You’ll need to calculate a separate Required Minimum Distribution from each of your retirement accounts. But for IRAs and some annuity accounts, you can withdraw the sum total from one account at a time. For instance, if you have four IRAs with RMDs of $3,000, $5,000, $2,500, and $4,000, you can withdraw the $14,500 from whichever account is netting you the lowest annual return. Leaving money in better-performing accounts will give you more to work with long term.
- Consider converting to a Roth. In some cases, having a Roth IRA can help you in the long term by giving you more flexibility in your retirement account withdrawal strategy.
- You don’t have to take more than the RMD. Some people incorrectly believe they’ll need to take more than the RMD to empty accounts in a certain amount of time. As this blog post from Asset Builder outlines, that isn’t true. In fact, when you’re in the first stages of taking an RMD, your accounts could continue to grow because the RMD percentage may be less than your annual returns. To figure out how long your accounts are likely to grow, rather than shrink, check out the RMD calculator from Fidelity.
As with most retirement-account topics, it’s best to talk with your adviser about your Required Minimum Distribution and how you can work to create the best possible retirement based on your savings. Even if you’re years away from 70 1/2, understanding RMD rules can help you better plan your retirement savings strategy.