Guide to Required Minimum Distributions

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Required minimum distributions (RMD) are mandatory once you retire and reach 73. The RMD is the smallest amount that can be withdrawn from a tax-deferred retirement account yearly. You’re required to take distributions from various retirement accounts. 

But it can be confusing as to what and when you should take the distributions. Who decides how much you take, and does it affect Social Security payments? 

What Retirement Plans Are Affected by RMDs?

In general, you must take withdrawals from your pretax accounts. These include:

• traditional individual retirement account (IRA)
• simplified employee pension (SEP) IRA
• SIMPLE IRA (savings incentive match plan for employees IRA) 
• various retirement plan accounts

As of 2024 or later, Roth IRAs don’t come under the RMD rules. But you should have taken RMDs in 2023. They do need to be withdrawn after the plan holder has passed.

Those in a workplace retirement plan like a 401(k) or profit sharing can delay RMDs until required, no matter how old they are. The exception is if you’re five percent or more owner of the business sponsoring the plan.

You can withdraw more than the minimum required. But whether you’re taking the minimum or more, the withdrawals are considered taxable income.

How Is an RMD Calculated?

According to the Internal Revenue Service (IRS), an RMD is calculated for each account. You divide the prior Dec. 31 IRA or retirement account balance by a life expectancy factor. Here is an AARP RMD calculator.

You must calculate the RMD separately for each IRA you own. But you can withdraw the total amount from only one if you wish. 

However, RMDs from accounts like 401(k) and 457(b) plans must be taken separately from each plan account. 

What Is the 4 Percent Rule for an RMD?

Designed on the old 4 percent rule, annual withdrawals are limited to 4 percent of the total balance in your first year of retirement.

The theory is that it’s safe enough, so you don’t run the risk of running out of money during a 30-year retirement. 

This rule assumes you have 50 percent of your investments in equities or stocks and 50 percent in fixed-income assets, such as bonds.

It also assumes that you have funds in a tax-deferred portfolio like a traditional IRA or 401 (k) that you’ll have taxable income.

The problem is that it depends on your circumstances and is, therefore, not a hard rule. If you have a large retirement portfolio, you may not need to withdraw 4 percent yearly. If you have a small portfolio, 4 percent might not be enough to cover your needs.

And the 4 percent rule doesn’t take several risks into account. Some of these are:

• health risk
• longevity risk
• market risk
• spending risk
• tax risk
• sequence of returns risk

No single rule will cover your circumstances. Consult with a financial advisor to determine what might work best for you.

Do RMDs Affect Social Security or Medicare?

RMDs increase taxable income. The result is certain Social Security and Medicare calculations could be impacted.

For example, those with higher incomes might be subject to higher Medicare premiums.

Are RMDs Taxed?

RMDs are taxable income. They are taxed as ordinary income at your federal tax rate. You will probably owe state taxes as well. The result is a high tax bill.

If you try to avoid the RMD or don’t take enough, you will be levied a penalty tax. Before the Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0, the penalty tax was 50 percent. But since the act it has been reduced to 25 percent.

However, if you correct the mistake during a two-year “correction window,” the penalty is reduced to ten percent.

The only way to avoid taxes on an RMD is to donate it directly from the retirement account to a charity. This is called a qualified charitable distribution (QCD). However, it must go directly to the charity; it can’t go to you first.

Talk to your plan administrator about setting up a QCD.

Can RMD be Reinvested?

An RMD cannot be reinvested into a retirement account if you don’t have earned income. You wouldn’t want to do this anyway. You think you’re receiving tax deferred growth, but when you take it out again, you’ll be taxed again. That’s a double tax.

Roth IRAs don’t require withdrawals until death. You can convert the RMD to a Roth at any time. But you might want to consider the tax consequences, so it’s wise to speak to a tax attorney.

Is It Better to Take RMD Monthly or Annually?

Whether you take a RMD annually or monthly depends on your lifestyle and financial needs.

Many retirees will take quarterly RMDs, but monthly is the most common approach.

If you’re taking one lump sum annually, consider withdrawing at the end of the year to earn one more year of interest on your money.

Check with a financial adviser to see what will work best for you.

What Is the Biggest RMD Mistake?

The biggest mistake retirees make regarding their RMD is not taking it. By not taking it, you lose money to the penalty tax.

Check with your plan administrator about taking timely RMDs.

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