How to Get Your Required Minimum Distribution Right

If you are investing in a traditional retirement account such as a 401(k), a 403(b), an Individual Retirement Account (IRA), or other similar options, you will need to deal with Required Minimum Distributions (RMDs). RMDs are the minimum value that you must withdraw from these accounts once you reach a certain age.

There are specific Required Minimum Distribution rules that you must follow when taking withdrawals. If these rules are not followed, you could face penalties and other consequences. While you can always reach out to a financial advisor to understand these rules in detail, knowing the basics can help you stay prepared. This article can help you understand how to calculate the Required Minimum Distribution and educate you on the rules of taking your distributions correctly.

What is a Required Minimum Distribution?

Required Minimum Distributions (RMDs) refer to the minimum amount of money that you need to withdraw from certain retirement accounts every year once you reach a specific age. These rules are set by the Internal Revenue Service (IRS) to ensure that you pay the liable tax on your retirement savings that grew tax-deferred all these years.

There are many types of retirement accounts. Some of them offer tax advantages by allowing you to contribute on a tax-deferred basis. The money you put in is not taxed in the year you make the investment. These investments grow over time without being taxed.

Sounds great, right?

It is, as it helps your savings grow faster over the years. But the money has to be taxed in the future, and the government eventually steps in when you make withdrawals. Required Minimum Distribution rules are mandatory to ensure you make these withdrawals at a certain age, so taxes can be collected.

Currently, most people must begin taking Required Minimum Distributions at age 73. However, this rule is set to change again. Beginning in 2033, the minimum age for Required Minimum Distributions will increase to 75.

However, until then, 73 is the important number to keep in mind. Once you reach the required age, you must start withdrawing a minimum amount of money from your retirement account every year. The exact amount for your distribution depends on your account balance and life expectancy factors set by the IRS. More of this will be discussed in the next section.

Several types of retirement accounts are subject to Required Minimum Distribution rules. These include employer-sponsored retirement plans such as traditional 401(k), 403(b), and 457(b) plans. Your Traditional IRAs, Simplified Employee Pension (SEP) IRAs, Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE) IRAs, and other defined contribution retirement plans are also subject to Required Minimum Distributions.

However, not all retirement accounts are subject to mandatory withdrawals. For example, Roth retirement accounts are typically not subject to Required Minimum Distribution rules while the account owner is alive. The rules for Roth accounts usually apply only after the account holder passes away and the assets are inherited by a beneficiary.

Your first Required Minimum Distribution must generally be taken by April 1 of the year following the year you turn 73. After that, you must take a distribution every year by the required deadline. Failing to withdraw the correct amount can lead to penalties.

Now, you would not want to pay a penalty on your hard-earned money, would you? This is why it is important to calculate your distribution amount carefully, make sure you withdraw the correct amount, and meet the deadline each year.

How to calculate the Required Minimum Distribution?

The exact amount you need to withdraw each year changes over time because it is based on your age and life expectancy. But, say you are calculating your distribution for the current year. All you need to do is use the IRS formula. The formula divides your retirement account balance by a life-expectancy factor. This factor can be found on official IRS tables. As you grow older, this factor changes each year, which means your Required Minimum Distribution amount will also change.

Here’s how to calculate the Required Minimum Distribution:

• Check your account balance and look at the value of each tax-deferred retirement account as of December 31 of the previous year.
• Find your distribution period by using the IRS life expectancy table. The table lists the distribution periods corresponding to your age in the current year.
• Divide the account balance by the distribution period to determine the amount you must withdraw for the year.

Let’s take an example:

Let’s assume you have a 401(k) with a total of $500,000 as of December 31 of the previous year. Now, to calculate the Required Minimum Distribution for the year you turn 73, you need to find the life-expectancy factor for age 73 in the IRS table and divide the account balance by that factor.

$500,000/life-expectancy factor = Required Minimum Distribution for the year

The result gives the minimum amount that must be withdrawn from the account for that year.

It is important to remember that you are free to withdraw more than the required amount if you need the money. So, say you have enough retirement income coming in through other places. In this case, you can take only the minimum and leave the rest invested. Your money will keep growing, and you will not have to pay a penalty. You can also choose to withdraw more than the required amount. This can be the case if you have fewer savings coming in from other sources.

You are the one ultimately calling the shots. You also have flexibility in how you take the withdrawal. You do not have to withdraw the entire amount at once unless you want to. Many people set up automatic withdrawals so the money is distributed throughout the year. For example, you could take the amount in monthly payments, quarterly installments, or a single lump sum. As long as the total amount is withdrawn during the year, you are good.

In most cases, you must withdraw your Required Minimum Distribution for the year by December 31. However, the first year you are required to take a Required Minimum Distribution comes with a small exception. You may delay the first withdrawal until April 1 of the following year. You can mark the date in your calendar to ensure you do not miss the deadline. Many retirement account custodians also send a notice each January showing the amount they estimate you must withdraw.

If you have multiple IRAs, the IRS permits you to combine the Required Minimum Distribution amounts for all of your IRAs, including SEP IRAs and SIMPLE IRAs. After calculating the required amount for each account, you can withdraw the total from just one IRA if you prefer.

However, this Required Minimum Distribution rule applies only to IRAs. IRAs may also have special considerations when they are inherited. The IRS provides a separate life expectancy table for IRA owners whose spouse is more than ten years younger and is the sole beneficiary of the account. There is also a separate table used when calculating distributions for beneficiaries of retirement accounts.

What about RMD penalty and compliance?

When it comes to Required Minimum Distributions, the IRS expects you to follow the rules carefully. There can be no lapses and delays. And even though account custodians may send some reminders to account holders, the responsibility ultimately falls on you. If you do not take the required amount, the IRS can and most likely will impose a penalty. Here’s how:

If you fail to take your Required Minimum Distribution on time, or if you withdraw less than the required amount, you would owe the IRS a standard penalty of 25% of the amount that should have been withdrawn but was not. For example, if your Required Minimum Distribution for the year was $20,000 and you withdrew only $15,000, the remaining $5,000 shortfall could be subject to the penalty. In this case, you could be charged a $1,250 penalty.

However, the rules do offer a bit of relief if you correct the mistake quickly. If you realize the error and withdraw the remaining amount within two years, the penalty may be reduced to 10% instead of 25%. So, taking the above example, you may only pay $500 instead of $1,250 as a penalty.

If you miss a Required Minimum Distribution or take less than required, you will also need to report the issue to the IRS. This is done by filing Form 5329, titled “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” The form is submitted along with your federal tax return for the year in which the distribution should have been taken.

In some cases, you may be able to request a waiver of the penalty. But you can only do this if the shortfall resulted from a reasonable error and you are taking steps to fix it. The IRS may reduce or eliminate the penalty if it deems the reason reasonable. This is not guaranteed, but you may have some success.

Also, while the Required Minimum Distribution rules are generally strict, there have been rare situations where the IRS temporarily suspended them. For example, Required Minimum Distributions were waived in 2009 during the global financial crisis. A similar one-year suspension happened again in 2020 during the COVID-19 pandemic. Because markets were extremely volatile at the time, the government allowed retirees to skip their Required Minimum Distributions for that year without facing penalties. These exceptions, however, are very rare.

Remember the Required Minimum Distribution rules to maximize your savings

It is important to understand the Required Minimum Distribution rules not only to avoid penalties but also to ensure that the money you have saved over the years is withdrawn in a timely and efficient manner. But do not worry. You do not have to remember every rule in detail. For now, just remember the key age, which is 73. Once you reach this age or are close to it, you can speak with your financial advisor, who can guide you through the rest of the process and help you manage your withdrawals correctly.

Explore our financial advisor directory to find vetted professionals near you before you take your first Required Minimum Distribution.

Frequently Asked Questions (FAQs) about Required Minimum Distributions (RMDs)

1. What is the current age for Required Minimum Distributions?

At present, you are required to start taking Required Minimum Distributions when you turn 73. However, the starting age is set to increase again in the future. Beginning in 2033, the age for Required Minimum Distributions will move up to 75.

2. What happens if I do not take my Required Minimum Distribution?

If you fail to take your Required Minimum Distribution on time, or withdraw less than the required amount, the IRS can impose a penalty. The standard penalty is 25% of the amount that should have been withdrawn. If you withdraw the remaining amount within two years, the penalty may be lowered to 10% instead of 25%.

That said, you must always remember your deadlines. Mark reminders on your phone or automate your withdrawals to ensure you do not miss your Required Minimum Distribution.

3. What is the IRS Uniform Lifetime Table?

The IRS Uniform Lifetime Table is a tool used to calculate how much you need to withdraw from your retirement account each year once Required Minimum Distributions begin. Your first Required Minimum Distribution is based on how much money you have in your tax-deferred retirement accounts at the end of the year before you turn 73. From there, the amount you must withdraw each year is determined using a life expectancy factor provided by the IRS Uniform Lifetime Table.

4. What happens if I withdraw more than my Required Minimum Distribution? Does it carry forward?

No. Each year’s Required Minimum Distribution is calculated independently based on the prior year’s account balance and the applicable life expectancy factor. Taking more than the required amount in one year does not reduce the distribution that you need to withdraw in future years.

5. How much tax do I have to pay on my Required Minimum Distribution?

Your distributions are taxed at ordinary income rates. You will be taxed as per your total income for the year. The distribution will be added to your annual taxable income, and the tax rate will be levied as per your income bracket and filing status. You can speak to a financial advisor to understand this in detail.

For additional information on retirement planning strategies tailored to your specific financial needs and goals, please visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm that manages private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services tailored to each client’s unique needs, providing institutional-caliber money management services based on a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.