RMD rules: What is a required minimum distribution?

If you’ve contributed to an individual retirement account (IRA) or employer-sponsored retirement plan over the years, the day will come when you must begin withdrawing money from your plans and begin paying taxes on it.

Required minimum distributions, or RMDs, are Internal Revenue Service-mandated withdrawals from qualified retirement plans once you reach a certain age. If you’re an account owner of traditional IRAs or employer-sponsored retirement plans, the IRS mandates that you take a required minimum distribution annually by a specified deadline. Understanding RMDs, the rules related to required distributions and the tax ramifications of your withdrawals are essential components of making the most of your retirement dollars.

What retirement accounts have required minimum distributions?

RMD rules apply to retirement accounts into which you’ve made tax-deferred contributions, including traditional IRAs and other IRA-based plans like SEPs, SARSEPs, and SIMPLE IRAs. Other retirement accounts subject to RMD rules include employer-sponsored plans, such as 401(k)s, 403(b)s and 457(b)s, as well as Roth 401(k) accounts.

When do I have to take a required minimum distribution?

You do not have to take RMDs right at retirement. The rules say that if you turned 70½ before Jan. 1, 2020, you must begin taking your RMDs at age 70½. If you reached 70½ on or after Jan. 1, 2020, you must begin withdrawals at age 72.

However, an employer can require you to take RMDs earlier than the tax code, so make sure you understand the terms of your plan. The IRS does not require you to take an RMD from your workplace retirement plan until you retire or terminate.

When is the deadline for withdrawing required minimum distributions?

According to RMD rules, the deadline for withdrawing your RMD is April 1 of the year after you reach the qualifying age and December 31 for each subsequent year. The IRS penalty for failing to take all or part of your required minimum distribution by the deadline is steep: 50% of the amount not taken on time.

If you delay your first RMD until the following year and before April 1, you will have to take two RMDs that year—the first by April 1 and the second by Dec. 31. For example, if you turn 72 in May 2022, you may delay your first RMD to April 2023. However, you must also take a second RMD by Dec. 31, 2023.

Note that there are tax ramifications for taking two RMDs in the same year and may put you in a different tax bracket, increasing the amount of income tax owed.

How do I calculate required minimum distributions?

As the account owner, you’re responsible for calculating the minimum distribution amount each year by dividing your year-end account balances on your eligible accounts by the life expectancy factor found in the IRS’s Uniform Lifetime Table.

Here's how RMD calculation would play out in a hypothetical situation.

Scott is 72 and married to Deborah, who is 68. Scott has one tax-deferred IRA. To calculate his annual required minimum withdrawal, Scott starts with the balance on his account on Dec. 31 of the preceding year: $495,000. He divides this amount by the life expectancy factor of a person's age and life situation using the IRS Uniform Lifetime Table to arrive at the estimated RMD for the year. For Scott, this factor is 27.4.

Using this formula, Scott’s required minimum distribution for the year is $18,065.69.

$495,000 ÷ 27.4 = $18,065.69

If Scott fails to take his required minimum deduction by the required deadline, he could be subject to the 50% excess accumulation penalty and may be required to file Form 5329 with his federal tax return for the year in which he did not take his RMD. In this case, Scott should receive further guidance from his tax advisor.

If an IRA owner’s spouse is their sole primary beneficiary and is more than 10 years younger than the IRA owner, their RMD is based on the joint life expectancy table.

RMDs and Roth accounts: When can I withdraw from a Roth IRA?

Roth 401(k) accounts are subject to the same RMD rules as traditional 401(k) accounts. However, one of the advantages of a Roth IRA is that it is not subject to the same RMD rules as other tax-deferred retirement accounts. The IRS does not require you to take RMDs on a Roth IRA while you’re alive, which means you can let the account grow tax-free for your beneficiaries.

RMDs and Inherited IRAs: Cashing out an Inherited IRA

If you’re the beneficiary of someone’s IRA account, you have several options. You could:

• Open your own IRA and continue tax-deferred growth with the option to make withdrawals immediately without penalties.
• Take the inheritance in a lump-sum withdrawal for immediate access to the funds. However, you could pay income taxes on the taxable portion of the distribution and possibly move to a higher tax bracket.
• Choose not to accept the inheritance and pass it to the next eligible beneficiary. But you must act within nine months of the original IRA owner’s death.

A financial professional can help you decide which option is best for you.

RMDs and taxes: How are required minimum distributions taxed?

The IRS taxes RMDs as ordinary income, and it will count toward your taxable income for the year, except for any after-tax contributions. RMDs are subject to applicable federal income tax rates and may also be subject to state and local taxes.

Keep in mind that, depending on the amount of your RMD, or if you take more than the required minimum distribution, this may put you in a higher tax bracket, which could also affect the taxes you pay for Social Security or Medicare.

Using RMDs for qualified charitable distributions (QCDs)

If you’re 70½ or older, you may want to consider a qualified charitable distribution (QCD). A QCD allows you to distribute up to $100,000 from your IRA to a qualified charitable organization, even if you aren’t yet taking RMDs.

With a QCD, you do not claim any income from a distribution. Instead, the full amount of your donation goes to the directed charities, and you avoid a significant taxable increase to your income. This may allow you to stay in a lower tax bracket and potentially avoid the 3.8% Net Investment Income Tax (NIIT). It also potentially allows you to minimize your tax liability for Social Security or Medicare Part B premiums.

Beneficiaries of inherited IRAs who are over 70½ can also complete QCDs.

RMDs and retirement planning

As you plan for your retirement, it’s vital to establish a financial strategy to generate income in a tax-efficient way. RMDs are an essential part of any strategic retirement plan. They affect not only your cash flow but also have critical tax implications.

When planning for your retirement, also keep in mind that qualified charitable giving offers an excellent opportunity to enhance your giving while achieving greater tax benefits. Our comprehensive retirement checklist can help you learn more about other key areas you should consider when planning for retirement.

Learn how we can help you create your retirement income strategy.