In this article, we’ll discuss what required minimum deductions are and what they could mean for you in your retirement years.
What Are Required Minimum Distributions?
Required minimum distributions (RMDs) are basically withdrawals that you are forced to take from your retirement accounts once you reach a certain age — typically 70 1/2, or when you retire if you work longer than that. Accounts that are affected by RMDs include:
- 401(k) plans
- Roth 401(k) plans
- 403(b) plans
- 457(b) plans
- Profit-sharing plans
- Individual Retirement Accounts (IRAs)
- Simplified Employee Pension Individual Retirement Accounts (SEP IRAs)
- Savings Incentive Match Plans for Employees (SIMPLE IRAs)
Roth IRAs, on the other hand, are not subject to required withdrawals until after the owner of the account dies.
When Do You Have to Start Taking Your RMDs?
As mentioned, if you’re alive at age 70 1/2, that’s when you’re required to start taking your required minimum distributions.
However, you don’t have to withdraw the money immediately that day. You can wait to receive your first payment until April 1 of the year following when you turn 70 1/2.
Once you take your first distribution, you must take a distribution by December 31 of that year and every following year.
How Do You Figure Out What Your RMD Will Be?
Basically, the amount you must withdraw from your account each year is determined by a formula that considers how much money is in your account and divides that by the number of years the government thinks you have left to live. You can find those tables here.
Bankrate provides a pretty handy calculator that lets you see what your estimated required minimum distribution is both at present (if you’re already 70 1/2) and in the future.
We ran the numbers on someone who is currently 50 years old and has $300,000 in a retirement account with an average rate of return of 5% per year:
As you can see, this person would be required to withdraw around $30,000 at 70 1/2. That number increases slightly each year until they are in their early 90s, if they are lucky enough to live that long.
What’s also interesting to note (in the graph on the bottom) is that the value of the retirement account never drops below $300,000, even if this person lives to be 100 years old.
What Happens If You Have More Than One Retirement Account?
If you have more than one IRA, you must calculate the RMD on each individual account. However, you can withdraw the total of the RMDs from one or more of those accounts. You do not have to take the RMD from each account individually. This applies to multiple 403(b) accounts, as well.
RMDs from other types of retirement accounts like 401(k) and 457(b) plans must be taken from each individual account, however.
How Do Taxes Work With RMDs?
In general you will pay taxes at your income tax rate on the amount of the distributions. However, certain exceptions apply.
What Happens If You Don’t Take Your Required Minimum Distributions?
The penalties for not taking your required minimum distributions are stiff, to say the least. According to the IRS:
“If an account owner fails to withdraw a RMD, fails to withdraw the full amount of the RMD, or fails to withdraw the RMD by the applicable deadline, the amount not withdrawn is taxed at 50%.”
So, unless you want to lose half of the money that you were required to withdraw in a particular year, to need to stay on top of your RMDs and make sure to take them by the deadline.
It may seem odd that the government forces you to withdraw some of your retirement savings each year, but the bottom line is that you worked hard for that money and were smart about saving it.
Instead of looking at it as a burden, think of it as a way to ensure you’re putting that money to good use to enjoy healthy and happy retirement years for yourself and your family.