Few things are as alluring as a smaller tax bill, and that’s one of the benefits you may get when you save with tax-deferred retirement plans and IRAs. The time to pay your fair share to Uncle Sam must come around eventually, though—usually when you retire and start turning those savings into income.
Retirement savings are vulnerable to a number of risks: Market volatility could lower your investments’ value, inflation could put a dent in your purchasing power over time, cognitive issues could make it harder to handle retirement income withdrawals, and living longer than expected could mean you outlast your retirement accounts. Annuities, a type of retirement investment that can be used to provide guaranteed income for life, can help with all of those risks.
Most types of tax-deferred retirement accounts require you to begin annual withdrawals—referred to as required minimum distributions, or RMDs—the year you turn 72 (as of January 1, 2020). You probably have questions about how that works, so keep reading—here are the answers.
What is a required minimum distribution (RMD)?
Generally, an RMD is the amount that the Internal Revenue Service, or IRS, requires you withdraw each year from your tax-deferred retirement accounts, including most employer-sponsored retirement plans or IRAs, by April 1 of the year after you turn 72. It’s important to think about how an RMD fits into your overall retirement income plan—either individually, or with a spouse or partner.
What are the RMD rules?
Simply put, the RMD rules are federal tax regulations that require you to begin these withdrawals. The regulations can get complicated quickly, so make sure you know which of your accounts have RMD requirements, when you need to begin withdrawals, and how much you need to take. (There's more on how the math works below.)
The RMD rules for inherited retirement accounts work differently. It’s a good idea to turn to a financial professional and tax advisor for help.
What about RMD age of eligibility?
As of January 1, 2020, RMDs must start the year you turn age 72. The rules will vary depending on whether you have turned age 70½ by December 31, 2019, or not. During the first year the RMD deadline is extended, giving you some leeway. So, suppose you turn 72 in 2020: You’ll need to take your first RMD by April 1, 2021. If you choose to wait until the last minute, be aware that your next RMD is due December 31 in the same year. That means you’ll be taking two RMDs in a single tax year.
What if I don't take an RMD?
Missing an RMD is no joke. If you fail to take an RMD, you’ll face a 50% penalty from the IRS on however much you fell short. Let’s say your RMD is $5,000 in year X and you only take out $4,000 by December 31. You will owe the IRS 50% of $1,000, the amount you failed to take out. RMDs are serious business, so it’s crucial you know your RMD amount and plan accordingly.
If you have a Roth IRA, you don’t need to worry about RMDs because none are required during your lifetime. The same is not true, however, for a Roth 403(b) or 401(k)—minimum distributions do need to be taken from these accounts.
Is there a simple way to learn how to calculate an RMD?
To calculate your RMD amount, find the balance of your retirement account as of December 31 of the previous year and divide it by the “distribution period” for your age. You can find your distribution period in this RMD table . If you start your RMD at 72, the first withdrawal amount works out to be 3.91% of your balance, a percentage that increases each year.
You’ll need to do this calculation for each of your tax-deferred IRAs and workplace plans, or basically all the accounts you have with pretax money (for which contributions were taken from your gross income), as well as for any 401(k)/403(b) accounts. For your traditional IRAs, you can add up the total for all these minimum amounts and withdraw that amount from any one or more of your IRAs. It doesn’t matter which one.
The same goes for multiple 403(b) accounts—you can aggregate all amounts and withdraw the total from just one account. You don’t have to take a separate RMD from each account (as is the case with other defined contribution plans, such as a 401(k) plan, where RMDs have to be taken from each separate plan). A quick note on 403(b) retirement plans: Any contributions and earnings credited before 1987 are not subject to RMD rules until the year you turn 75 years old.
Keep in mind that if you are already making withdrawals, you may have met the requirements already.
It doesn’t matter what time of year you make the withdrawals as long as the full RMD amount is taken by December 31. RMDs will then be due every year after that.
It is also a good idea to consider rebalancing your investments whenever you take out money to keep your portfolio diversified.
What if I haven't retired yet?
People increasingly are working beyond their 60s. If you’re employed past age 72, you won’t have to take a single distribution from your current employer plan until you retire—as long as your employer’s plan allows it. But any accounts you have with previous employers, or traditional IRAs, will be subject to RMDs.
By rolling other retirement accounts into your current employer’s plan, you may be able to delay your RMDs on that money, too, as long as you’re still working. Just make sure you take your RMDs on any accounts other than your current employer’s plan before consolidating to ensure you meet this year’s RMD requirements for those accounts.
You should consider seeking guidance from a financial professional and a tax advisor before consolidating assets. A financial advisor can help you see how much you owe, whether you can afford to defer those RMDs, and what your options are in terms of consolidation. Converting everything to a Roth IRA, for example, is one way to defer RMDs for the rest of your life—but can you afford the immediate tax bite? An advisor can help you determine what is in your best interests and alert you to unanticipated tax consequences: Deferring your RMDs by consolidating everything into your current employer plan, for instance, may make your RMDs so high that when you finally take them, they push you into a higher tax bracket.