The RMD is a milestone that you must reach to continue with your retirement plan. This tax-deferred amount will be used as an investment. The IRS requires that you withdraw a certain amount from your account and pay taxes on it by the time you reach age 73.
The RMD calculation is based on your life expectancy, the account balance at the end of the previous year, and a distribution period from an IRS table. This amount will be recalculated every year.
If you have more than one retirement account, it is important to include the RMDs from each of these accounts. You are given one year in which to make your individualized calculations.
Types of Plan That Require an RMD
We will explain the exceptions and how to calculate RMDs below. But first, let's see what types of plans require these requirements for retirement savings:
RMDs do not apply to Roth IRAs because the contributions are made with after-tax dollars. However, inherited IRA accounts do require regular monitoring and funding according to the specifications set out in one's will or other legal document establishing inheritance rights.
This includes paying taxes on any gains made when they sell assets built up before becoming eligible for the retirement tax exemption at age 73.
Due to the coronavirus pandemic, RMDs for 2020 were waived.
RMD Table
The distribution period is based on your life expectancy, as stated in the following table:
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You should then follow these steps:
- Find your age on the IRS Uniform Lifetime Table.
- Find and use the “life expectancy factor” that corresponds to your current age.
- Divide the balance of your retirement account (as of December 31 of the previous year) to your age's life expectancy factor.
What Happens If I Withdraw Too Little or Do not Take an RMD?
If you withdraw too little, the RMD for the following year will be larger to make up for this. The IRS also charges a 25% penalty on the amount that was not withdrawn.
If you do not take an RMD, you will have to pay a 25% penalty on the amount that should have been taken out.
RMD Deadlines and Exceptions
In the first year that you are required to take an RMD, you are allowed to delay it until April 1 of the following year. But after that, you will have to take another RMD by December 31 of that year, else it will count as taxable income and place you in a higher tax bracket.
A tax professional or financial advisor with expertise in taxes could help you figure out how much money needs to be drawn down from various accounts before deciding where exactly those funds should go.
Another way to delay taking your RMD is if you are still working at the company that sponsors your 401(k) plan or another employer-sponsored plan. This is as long as you do not own 5% or more of that company.
By doing this, you can delay taking your first RMD until after your retirement. Once you leave that company and turn 73, you must take your RMDs.
To calculate your 401(k) RMD, you should use the same table and steps as for calculating traditional IRA RMDs.
RMDs and Inherited IRAs
The rules for required minimum distributions and inherited IRAs are a little more complicated. Here is how it works:
If you inherit a traditional or Roth IRA from someone other than your spouse, you must start taking RMDs by the end of the year following the year of death. You should use the beneficiary life expectancy table to calculate how much you must withdraw each year.
If you are the spouse of the deceased, you have the option to either continue taking RMDs based on your deceased spouse's life expectancy or recalculate your own RMD using your own life expectancy. You can also roll over the IRA into your own account and treat it as your own.
If you are a non-spouse beneficiary, you must take annual RMDs over your life expectancy or until the account is depleted. You cannot roll over an inherited IRA into your own account.
RMDs and Inherited 401(k)s
If you inherit a 401(k) from someone other than your spouse, you must start taking RMDs by the end of the year following the year of death. You will use the beneficiary life expectancy table to calculate how much you must withdraw each year.
If you are the spouse of the deceased, you have three options:
- Take annual RMDs over your life expectancy or until the account is depleted.
- and start taking RMDs based on the beneficiary life expectancy tRollover the 401(k) into an inherited IRA table.
- Combine the two accounts (the inherited 401(k) and your own current 401(k)) into a single account, and start taking RMDs based on your own life expectancy.
If you are a non-spouse beneficiary, you must take annual RMDs based on your life expectancy or until the account is depleted. You cannot also roll over an inherited 401(k) into your own account.
How to Avoid RMDs
As mentioned earlier, you can delay taking your RMDs if you are still working at the company that sponsors your 401(k) plan or another employer-sponsored plan.
You can also avoid RMDs by rolling over the money from a traditional IRA into a Roth IRA. This is known as a “Roth conversion” and must be done before you turn 72.
You can also avoid RMDs by taking your distributions for five years or less. This is known as the “Life Expectancy Method” and can only be used if you are the sole beneficiary of the account.
Last but not least, another way to avoid RMDs is to give away your money. You can gift up to $14,000 per year without having to include it in your taxable income. This could be a good option if you do not need the extra money each year and want to reduce your tax burden.
The Bottom Line
Required minimum distributions can be a complex topic, but it is important to understand how they work so that you can make the most of your retirement savings. If you have any questions, be sure to speak with a financial advisor or someone who specializes in taxes and retirement planning.
FAQs
1. When must I receive my required minimum distribution from my IRA?
You must take your required minimum distribution by the end of the year in which you turn 73. If you are still working and participating in a company or other employer-sponsored retirement plan, you can delay taking your RMDs until after you retire. After you retire (or reach 73 years old), you must take your RMDs by the end of that year.
2. Is it better to take an RMD monthly or annually?
It is up to you how you take your RMDs. However, if you choose to take them monthly, you must divide the total amount by 12 to get the monthly amount. If you choose to take them annually, simply divide the total amount by 365 (or 366 in a leap year). Keep in mind that if you take your RMDs monthly, you must make the withdrawal by the end of the month. If you take them annually, you have until December 31 to withdraw the total amount.
3. What happens if I fail to take my RMD?
The penalties for not taking your RMDs can be quite severe. You will owe a 25% excise tax on the amount you should have withdrawn but did not. In addition, you may also face fines and imprisonment. It is therefore important to make sure you understand how RMDs work and take the required withdrawals each year.
4. What happens if you take more than your RMD?
If you take more than your required minimum distribution, you will be subject to a 25% excise tax on the amount over the RMD. You should always aim to take the exact amount required each year to avoid any penalties.
5. Does an RMD count as earned income for Social Security?
No, an RMD does not count as earned income for Social Security. It is important to understand how your retirement distributions will impact other aspects of your financial life. Speak with a qualified advisor to get more information specific to your situation.
