No matter how far or near you are to retirement, you probably know it’s important to save for your future.
Something we don’t talk about as much is taking your money out when retirement finally arrives.
You may already know you need to wait until a certain age (59.5) before you can withdraw money from retirement accounts penalty-free.
But there are also penalties if you don’t withdraw enough money once you turn 72.
What Is a Required Minimum Distribution?
A required minimum distribution (RMD) is the amount of money you are required to withdraw from your retirement account each year after you turn 72.
You get the cash and Uncle Sam gets income tax on the withdrawal.
Your retirement plans are shielded from taxes during your working years, but the government doesn’t want to miss out on its cut forever.
That’s why most retirement accounts — except Roth IRAs — have required minimum distributions.
According to the Internal Revenue Service, you need to withdraw an RMD starting at age 72 if you have one of the following retirement savings accounts:
You must start taking RMDs no later than April 1 following the year you turn 72.
If you don’t withdraw the money, you’ll owe big bucks: Failing to take a distribution — or not withdrawing enough — can result in a 50% tax on the amount you didn’t take.
How much you’re required to withdraw changes from year to year and is based on IRS life expectancy tables.
8 Facts You Need to Know About Required Minimum Distributions
Required minimum distributions aren’t inherently bad. Most of us want — or frankly, need — to use the retirement money we saved up for years.
You might even consider yourself lucky. Many people work their entire lives and still run out of money in their retirement accounts before they turn 72.
Unfortunately, there’s no avoiding taxes when RMDs kick in.
Here are eight important things you should know about RMDs that will help you prioritize how you save now and how you withdraw later.
1. All Retirement Accounts Have RMDs — Except One
All retirement accounts — whether individual or from an employer — have RMDs. Even a Roth 401(k) and Roth 403(b) are subject to minimum distributions once you reach age 72.
There is one exception: Roth IRAs.
Roth IRAs don’t require RMDs while the account holder is alive. That makes these retirement accounts a great tool for young investors because you can let the money grow tax-free for the rest of your life.
2. You Might Be Able to Defer Your Required Minimum Distribution
As long as you’re working for an employer with a retirement plan such as a 401(k) or 403(b) that you’re actively contributing to, you can defer taking RMDs on that account. You can defer RMDs on that specific account until April 1 of the year after you stop working.
However, this “still working” exception only applies to a current employer’s retirement plan, not to IRAs or tax-deferred plans from previous employers.
That would be a good reason to roll over any 401(k)s from past employers into your current 401(k) before you turn 72.
Make sure to check with your employer to see if you qualify for a required minimum distribution deferral.
3. Your RMD Amount Will Change Every Year
The RMD amount you’re required to withdraw depends on how much is in your account and your life expectancy. You can use an online calculator to get a clear prediction of your specific withdrawal amount.
Use this RMD calculator from the U.S. Securities and Exchange Commission to figure out how much you need to withdraw.
Because these variables change every year, so does your RMD amount.
Distribution requirements typically move on a bell curve, increasing for the predicted first half of your retirement and decreasing in the second.
You can always withdraw more than your RMD, but you can’t apply the excess toward next year’s distribution.
4. Different Accounts Can Be Subject to Different RMD Rules
If you have more than one retirement account, each will have its own RMD rules, so it’s important to calculate them separately.
For example, you can combine multiple traditional IRA accounts (including SEP IRAs and Simple IRAs) and take an aggregate RMD for all of them.
However, the same rule doesn’t apply to defined contribution plans, such as 401(k) plans.
If you have multiple 401(k)s, RMDs must be calculated separately for each one. Again, this is a great reason to roll over your 401(k) to your current employer’s or a traditional IRA whenever you leave a job.
|You must calculate your RMDs separately for each retirement plan and withdraw that amount from that specific plan.|
5. Rollovers Can Protect You From Some RMDs
If you have a Roth 401(k) or Roth 403(b), you can roll these accounts over to a Roth IRA tax-free and avoid paying RMDs during your lifetime.
You can also do a Roth IRA conversion from your traditional IRA. It preserves money you want to keep invested in the market, which is good if your retirement savings are low.
But remember, you’ll pay income taxes when you convert from a traditional IRA to a Roth. If you have a large amount of money saved up in a traditional account or if you’re in a high tax bracket right now, you should consult a financial advisor before converting to a Roth IRA.
6. Knowing When to Take Your RMDs Is Important
It’s important to know your required minimum distribution deadlines. Otherwise you’ll face a hefty fee.
Here are the two RMD deadlines to know:
- The first time you take an RMD, you have until April 1 of the year following the year you turn 72.
- After that, you typically have until Dec. 31 of the current year to take that year’s RMD.
Be careful if you decide to delay your first RMD until April. You’ll still have to take another distribution in December, and two big withdrawals in the same year could push you into a higher tax bracket — and increase your tax bill.
7. There Are Fees for Not Complying
If you forget or decide you don’t want to comply with RMD rules, you’ll be charged income tax plus a penalty equal to 50% of your unwithdrawn distribution.
If the correct required minimum distribution is $4,000, for example, and you only withdraw $2,000, you’ll owe a tax penalty of $1,000 — half of $2,000.
If you made an honest mistake and didn’t withdraw enough money, you can file Form 5329 – Additional Taxes on Qualified Plans when you submit your taxes.
The IRS is known to waive penalties for incorrect RMDs if you act quickly and let the agency know ASAP.
You should also contact your retirement plan administrator and let them know when you plan to take RMDs. Some plan administrators, like Vanguard, even offer a free service that will calculate your RMDs automatically and withdraw the money and transfer it to a specified account at a specified time.
Some people don’t have to worry about RMDs because they need the money sooner.
Remember, you can choose to start taking penalty-free withdrawals from a retirement account as soon as age 59.5.
8. You Have to Pay Taxes on (Most) RMDs
Withdrawals from tax-deferred retirement accounts are taxed at your ordinary income rate. To figure out how much money you’ll owe in taxes, find your tax bracket.
Your required minimum distribution also counts toward your annual taxable income.
If you’re sitting on a big nest egg, keep in mind that RMDs can push you into a higher tax bracket. This can affect the taxes you pay for Medicare and Social Security.
You’ll never pay taxes on Roth account withdrawals because the money in these accounts has already been taxed. Roth withdrawals don’t count toward your taxable income, either.
How Do You Calculate Your Required Minimum Distribution?
Start by adding up all your IRA balances as of Dec. 31 of the previous year.
Your retirement plan custodian will send you a 5498 Form detailing your year-end account balance.
Next, locate your age on the IRS Uniform Lifetime table and the corresponding “distribution period.”
Finally, divide your account balance by the distribution period factor in the chart. (Note: You will need to figure the RMD for each 401(k) account separately).
Here’s an example.
Let’s imagine Marcos is 73 and has $100,000 in his traditional IRA on Dec. 31, 2021.
- According to the IRS table, his distribution factor in 2022 is 26.5.
- $100,000 divided by 26.5 = $3,773.58.
- Marcos’ RMD for 2022 is $3,773.58.
In this example, Marcos would owe about $830 in federal taxes if he’s in the 22% tax bracket.
Here is one small caveat to all this.
If you’re married, your spouse is the only primary beneficiary of your account and your spouse is more than 10 years younger than you, use the IRS Joint Life Expectancy table to calculate your RMD instead of the Uniform Lifetime table.
Know Where to Go for Help with Your RMDs
Unless you just love math and crunching numbers, figuring out your RMD can be tricky.
And as we’ve mentioned before, a simple mistake can cost you big.
It’s wise to use a RMD calculator so you don’t withdraw too much or too little from your accounts.
Need help reporting an RMD on your tax return? Consult a professional tax advisor. This is a smart move regardless, and especially if you’re subject to state taxes as well as federal taxes.
You can also work with a certified financial planner to determine the best way to spend or invest your withdrawals.
The best source of information about RMDs is IRS Publication 590-B. It contains detailed instructions, worksheets and up-to-date distribution period tables based on life expectancy.
Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder.