Required Minimum Distributions: What You Need to Know
It’s inevitable. Uncle Sam wants his piece of the pie, and that includes a portion of the tax-deferred balances you’ve been building. Even if you don’t need to take required minimum distributions (RMDs) yet, it’s essential to understand them so you can avoid costly mistakes in your retirement plan.
What Is an RMD?
RMDs are mandatory withdrawals from your tax-deferred retirement accounts. According to the IRS, these retirement plans include:
Traditional IRAs
SEP IRAs
SIMPLE IRAs
401(k) plans
403(b) plans
457(b) plans
Profit-sharing plans
Other defined-contribution plans
You won’t need to take RMDs from your Roth accounts since you made contributions with after-tax funds.
At What Age Do You Need to Take RMDs?
The timeline for beginning RMDs changed with the passage of the SECURE Act in late 2019.
Before January 1, 2020, you had to begin taking RMDs once you turned age 70 ½. However, with the SECURE Act’s passage, if you turn 70 ½ on or after January 1, 2020, you can now wait to take distributions until you are age 72.
You can also defer RMDs if you are still working. But if you are a 5%-or-more owner in a business that sponsors a retirement plan, you must begin RMDS at age 70 ½ or 72, depending on the rule that applies to you.
How Do You Calculate an RMD?
You’ll determine your RMD based on your account balance on December 31 of the previous year. Generally, you’ll then divide this amount by the distribution period taken from the IRS’s Uniform Lifetime Table, which is based on life expectancy. You’ll use a different table if:
You are an account owner whose spouse is younger than you by more than 10 years and is the IRA’s sole beneficiary (see Table II)
You are an IRA beneficiary who is not the spouse of the original IRA owner (see Table I)
The IRS provides worksheets to help you determine your RMD. You can also search the web for RMD calculators or work with a financial advisor with expertise in retirement planning. Our Greenwood Village, CO fiduciary financial planning firm helps clients determine their RMDs as part of the ongoing planning that they receive.
What happens if you have multiple accounts that need RMDs? The answer depends on the types of accounts you own:
IRAs: You will calculate a separate RMD for each of your IRAs, but you can withdraw the total RMD amount from just one account or multiple accounts.
403(b) plans: The rule for 403(b) accounts is the same as the IRA rule.
401(k) and 457(b) plans: You will need to take a separate RMD for each of your accounts.
It’s important to keep track of your required minimum distributions. The IRS can levy a penalty for 50% of any portion of an RMD that you did not withdraw.
Other RMD Rules to Know
An RMD establishes the minimum you must withdraw from your tax-deferred retirement plans. But if your income needs are greater than the minimum, then you are free to withdraw more.
Your RMD withdrawals must begin by April 1 of the following year that you turn 70 ½ or 72, depending on the age that applies to you. And for each year thereafter, you must complete a required minimum distribution by December 31.
That means you could end up taking two distributions when you reach the required age. That will happen if you defer your first RMD until April of the following year. You’ll then need to take the one required for the current year by December 31. Careful planning is necessary when it comes to distributions!
Inherited Retirement Accounts
The SECURE Act changed the way inherited retirement accounts are handled.
If you are the beneficiary of an IRA whose owner died before 2020, you will generally be able to “stretch” your withdrawals over your lifetime.
If you inherit an account in 2020 or after, you will have 10 years to withdraw the entire account balance unless you are:
A spouse of the deceased IRA account owner
A minor child (the 10-year provision applies once you reach the age of majority)
Chronically ill or disabled
Less than 10 years younger than the account owner (such as a sibling)
In such cases, the “stretch” rule applies to you.
Final Thoughts
For most retirees, taking an RMD is necessary since they’re using the money for living expenses in retirement. If you don’t need your RMD and are charitably inclined, you might consider whether a qualified charitable distribution (QCD) is right for you.
The IRS regulations around RMDs can get complicated. Here’s a quick checklist to review before making your RMD:
Understand the age you must begin taking RMDs.
Use the correct life expectancy table to calculate withdrawal amounts.
Remember that you have just 10 years to make withdrawals from an inherited IRA if the account owner died after December 31, 2019.
Finally, consider required minimum distributions as just one piece of your retirement puzzle. Your retirement plan should also incorporate other income sources such as Social Security, expenses, goals, and taxes.
If you are having trouble understanding how all the pieces can come together, you might want to talk with a fee-only financial advisor who provides comprehensive retirement planning. The peace of mind that you may gain with a professional who has the expertise to pull everything together, including your RMDs, can be invaluable.
Discuss your situation with a fee-only financial advisor. Schedule a complimentary discovery call.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
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