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What Are Required Minimum Distributions and How Are They Calculated?

Once you turn 72, the IRS wants you to start withdrawing from your retirement account, whether you need the money or not.

Required minimum distributions are IRS-mandated withdrawals from retirement accounts. The IRS requires these withdrawals to ensure that taxes are paid on amounts that were contributed on a pre-tax basis plus any tax-deferred earnings in these accounts over the years.

What Is a Required Minimum Distribution?

Required minimum distributions or RMDs are mandatory withdrawals that must be taken from retirement accounts beginning at a specified age. RMDs must be taken from the following types of retirement accounts:

  • IRA (including inherited IRAs)
  • 401(k)
  • 403(b)
  • 457

For account holders who reached the age of 70½ on or before Dec. 31, 2019, RMDs were required to commence in the year they reached age 70½. For the first distribution only, the account holder had until April 1 of the year following the year they turned age 70½ to take the first distribution. Going forward from there, RMDs must be taken by Dec. 31 of each year. The same timing will apply to RMDs going forward under the SECURE Act, for those covered by the new age of 72, to start taking their RMD.

RMDs for each year are based upon the balance in the account on Dec. 31 of the prior year. In the case of multiple IRA accounts, the account holder can generally choose to take the distribution all from one of the accounts or in any combination of the accounts as long as the total RMD amount is taken.

If the employer makes the proper election, plans such as a 401(k) or 403(b) can allow participants in that employer’s plan to defer their RMDs if they are age 72, still working and are not a 5% or greater owner of the business. This exemption does not apply to any other retirement owned by that individual such as an IRA or a 401(k) with a former employer.

The SECURE Act and RMDs

The SECURE Act that was signed into law near the end of 2019 changed the timing of RMDs. Those who will turn age 70½ on or after Jan.  1, 2020 do not need to start taking RMDs until age 72. Those who were taking RMDs before 2020 will need to continue taking distributions.

For spouses who have inherited an IRA account, or who have inherited a workplace retirement plan from their deceased spouse and rolled it into their own IRA, the RMD rules will apply to them for any distributions on these funds as well.

RMD rules for most non-spousal beneficiaries have changed under the SECURE Act rules. With the exception of minor children and those with disabilities, non-spousal beneficiaries will no longer take RMDs on IRAs inherited on or after Jan. 1, 2020. Under the new rules, these non-spousal beneficiaries will no longer take RMDs but rather must withdraw the entire account balance within 10 years of inheriting it.

How Are RMDs Taxed?

In the case of pre-tax contributions, there was a tax-break at the time the contribution was made. Additionally, any gains in your account have been allowed to accumulate and grow on a tax-deferred basis. When you withdraw these funds, the IRS wants their fair share, so to speak.

RMDs from traditional accounts are taxed as ordinary income. This means that the amount of the RMD is added to the rest of your taxable income for the year. Traditional accounts are those that are not Roth accounts.

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Any after-tax contributions made to these accounts would be excluded from the amount subject to tax, though you will have needed to keep track of these after-tax contributions. Earnings on these after-tax contributions will be subject to taxes as part of the RMD.

There are no RMDs required on a Roth IRA for the account owner or their spousal beneficiary. Non-spousal beneficiaries who inherit a Roth IRA are required to take RMDs, but those distributions are tax-free as long as the five-year rule for Roth IRAs was met.

A Roth 401(k) account is subject to RMDs at age 72 under the new rules if left with the company, but this can be avoided by rolling this money into a Roth IRA account.

In addition to any taxes due, there are penalties if you do not take the full amount of the RMD for that year. The penalty is 50% of the amount not taken, in addition to the taxes that will still be due.

Note a change in the rules a number of years ago mandated that the custodian of your IRA account must report the amount of the RMD to the IRS. This was designed to help the IRS enforce the 50% penalty for amounts not taken. Administrators of other retirement plans, such as a 401(k), that are subject to RMDs also must notify the IRS regarding any RMD that is due.

How Are RMDs Calculated?

RMDs are calculated using IRS tables contained in Internal Revenue Service Publication 590-B . These tables have factors for age and for several different situations including those for certain types of beneficiaries. The Uniform Lifetime Table is commonly used for many account owners.

The RMD is calculated by taking the ending balance from Dec. 31 of the prior year and dividing that amount by the appropriate factor. This amount must then be taken by the end of the year that the RMD applies to.

There are also life expectancy tables for a single life expectancy for non-spousal beneficiaries of a retirement account, as well as one for spousal beneficiaries where the inheriting spouse is more than 10 years younger than their spouse.

Example of a Required Minimum Distribution

Here is an example of an RMD calculation:

  • Account holder is age 75 in 2020
  • IRA account balance at Dec. 31, 2019 is $500,000

Under this scenario, there RMD for 2020 is $500,000 divided by 22.9 (the IRS life-expectancy factor for their age) which equals $21,834.06. This amount must be withdrawn from their IRA no later than Dec. 31, 2020. They can do this all at once, monthly, or on an as-needed basis during the year.