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What is Required Minimum Distribution (RMD)?

What is Required Minimum Distribution (RMD)?

After years of saving, you've built up a solid savings fund in your tax-supported retirement accounts. However, you cannot leave this money untouched indefinitely. After reaching age 72, you must start withdrawing a fixed amount each year, called the Required Minimum Distribution, whether or not you need the income.


What is an RMD?

An RMD (required minimum distribution) is the amount of money you must withdraw from almost all tax-preferred retirement accounts after age 72. As the name suggests, this amount is the minimum - you can withdraw more at any time.

Many retirement accounts allow your savings to grow tax-free for decades, deferring your income tax until you retire. By requiring you to start withdrawing your money, the government receives the tax revenue it expects and ensures that taxpayers do not accumulate unlimited tax-free wealth.

Previously, you had to start taking RMD at age 70½. In 2019, the SECURE Act (Setting Every Community Up for Retirement Enhancement) raised the age of RMD to 72 years. According to the act, if you turned 70 as of July 1, 2019, you should not start taking RMD until you are 72.

The following types of pension plans have RMD:

  • 401(k)

  • 403(b)

  • 457(b)

  • Profit-sharing plans

  • SEP IRA

  • Simple IRA 

  • Traditional IRA

The annual deadline to submit your RMDs is December 31. You can defer your first RMD until April 1 of the following year on your 72nd birthday. However, if you choose this route, keep in mind that you will have to deposit your first and second RMDs in the same year, which may cause you to pay more income tax than if you had done both during separate years. Talk to a tax expert if you are confused about how this works.

You can defer receiving RMDs from your current employer-sponsored pension plan if you still work at age 72.


RMDs are not required for Roth IRAs.

Roth IRAs are useful retirement accounts for several reasons, one of which is that they have no RMD. Regardless of age, you don't have to withdraw from a Roth IRA.

If you don't have a need for the money in your retirement account, you can leave it intact. You can save money for emergencies, pass it on to your children or grandchildren, or donate it to charity after you pass on. And if you choose to make withdrawals, they will never be taxed until at least five years have passed since you opened a Roth account. You've already paid taxes for what you invested in a Roth IRA.


How to calculate your RMD

To calculate the RMD, divide the tax-deferred retirement account balance as of December 31 last year by the standard life expectancy factor in the IRS mortality table.

Suppose John is 74 and single. As of December 31 of last year, John's IRA balance was $100,000. According to the Internal Revenue Service Uniform Lifetime Chart, John's life expectancy factor is 23.8. To calculate RMD, divide the balance by 23.8 to get $4,201.68. This is the minimum amount John must withdraw from the IRA to comply with the RMD rules.


What if my spouse is a different age?

If you are married and your spouse is more than 10 years younger than you, you must use another life expectancy factor to determine your RMD. The IRS has a separate table for couples with an age difference, called the joint life expectancy table. Using this table, the life expectancy factor is based on the age of both people.

For example, suppose Jane, 75, married John, 64. Jane's IRA balance is $100,000 as of December 31 of last year. The IRS common life expectancy chart shows that their factor is 23.6. Dividing the balance by 23.6, Jane's RMD is $4,237.29.


When should you take RMDs?

It is not necessary to take an RMD in the form of a lump sum. If you prefer, you can get your RMD in monthly or quarterly installments or any other way that suits your budget needs. There's no tax advantage when you withdraw money in smaller installments rather than a single lump sum - you'll pay the same amount in taxes anyway.

However, accepting payments at the start of the year can cost you in other ways. The sooner you withdraw money from your accounts, and the less your money will grow. If you wait until the end of the year to remove RMD can give you greater exposure to market gains. On the other hand, losses in the market at the end of the year could cancel out some earlier gains.

Another approach is the same with quarterly or monthly withdrawals, which balance the opportunity cost of more time to grow with the possibility of market losses at different times of the year. Think of it as the inverse average dollar cost. If you are unsure of the best RMD strategy for your needs, speak to a tax or financial advisor.


How are RMDs taxed?

Withdrawals from your retirement accounts are usually included in your taxable income unless your after-tax contributions were made to a Roth account. For instance, if you have a Roth 401(k), your withdrawals will not be included in taxable income.

Your RMDs can shift your income to a higher tax bracket, impacting your Medicare and Social Security taxes.


What if I don't take RMD?

The penalties for not taking RMD are high. If you do not take the requested RMD by December 31 or receive less than you need, you may be required to pay an excise duty of 50% of the undistributed amount, as requested.

For example, if you need to withdraw $4,000 but only withdraw $2,000, you will be charged a penalty of 50% of the $2,000 difference, and you should have $1,000 in excise duty.

If you believe you did not receive the correct amount of RMD, please file Form 5329: Additional Tax on Qualified Plans with the IRS when filing the charges. The Internal Revenue generally waives penalties for incorrect or missing RMDs if you take action and report them immediately.

If you're hesitant to take the RMD because you don't need it for immediate expenses, you have several options for using it effectively. You can donate to charities, invest in tax investments, such as municipal bonds, or buy a QLAC to reduce the size of the RMD.


RMD and Inherited IRA

If you inherit an IRA, you may be subject to RMD. When the original owner of the IRA dies, the nature of your relationship with the deceased determines the type of RMD you will face.

Also, note that if an RMD was requested from the original IRA owner in the year of their death but was not withdrawn before death, the designated beneficiary must obtain an RMD for that year.


If the original IRA owner died after December 31, 2019

The designated beneficiary of the IRA must repay all assets within 10 years. As a beneficiary of an IRA, you can withdraw money from your account at any time, in any amount you want, as long as your account is completely depleted by December 31, the 10th anniversary of the death of the original IRA owner. All the assets withdrawn from the IRA will be charged as ordinary income.

There are special cases for certain beneficiaries, including:

  • A person who is no less than 10 years younger than the original owner of the IRA

  • People with chronic illnesses

  • People with Disabilities

  • The minor child or spouse of the original owner of the IRA

People who qualify for these exceptions can choose to follow the 10-year rule described above or the RMD rules established for beneficiaries of IRA owners who died before January 1, 2020, as described below.


If the IRA owner died before January 1, 2020

When a beneficiary inherited an Individual Retirement Arrangement (IRA) from someone who died before they began taking RMDs, they had two options:

Lifetime Distribution

The beneficiary can choose to make withdrawals for life. How it worked depended on your relationship with the IRA owner.

• Spouse as the sole primary beneficiary: The spouse can choose to take the RMD based on life expectancy and must start taking the RMD by December 31 after the death of the original IRA holder or the year in which they reached the RMD age, whichever occurs later.

• Non-spouse and spouse as the non-sole primary beneficiary: A non-spouse beneficiary or a spouse who was not the sole beneficiary must begin taking RMD based on the life expectancy factor no later than December 31st of the year following the death of the original IRA holder.


Five-Year Rule

If there is only one beneficiary, you can choose to distribute the IRA assets within five years of the IRA owner's death. The distribution must be finalized by December 31, the fifth anniversary of the owner's death. Non-individual beneficiaries must use the five-year option if the holder dies before receiving the RMDs.


Roth IRA Inheritance Rules

Although RMDs are not required for primary Roth IRA owners, the rules for inherited Roth IRAs follow the above outlined rules.

If the money has been in the Roth IRA for at least five years, you can withdraw it tax-free, but the earnings are taxable if the account is less than five years old when the original owner dies.

If you inherit a Roth IRA from someone who died after December 31, 2019, you must withdraw all funds within ten years. The same exceptions apply to other inherited IRAs. If the original owner of the Roth IRA died before January 1, 2020, you could choose the lifetime distribution approach or the five-year rule described above.


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