Understanding Required Minimum Distributions (RMD) Rules

Required Minimum Distributions (RMD) are the funds the IRS requires you to take from your retirement accounts. Hadayeva Sviatlana/Shutterstock

When you make a contribution to a traditional Individual Retirement Account or 401(k), the tax liability on the funds you contribute is deferred until you take the money out of the account. That allows you to take full benefit of the interest earned by those accounts.

But, the government is going to get its tax dollars from you at some point, and that occurs when you withdraw funds from your retirement accounts. The IRS imposes Required Minimum Distributions (RMD) from retirement accounts to prevent you from avoiding the taxes owed on those contributions, and to keep you from hoarding cash.

An RMD is the amount you must withdraw from your account every year after the RMD period begins. Roth IRAs, however, do not require withdrawals until the account owner passes away.

Let’s look at the accounts that have RMDs, and the rules regarding those distributions.

Types of Accounts That Include RMDs

Most accounts that allow you to put money away for use as income in retirement include RMDs. Those accounts include 401(k), 403(b), and 457(b) plans, traditional IRAs, IRA-similar plans such as a Simplified Employment Pension Plan (SEP), and a Savings Incentive Match Plan for Employees (SIMPLE IRA). Roth 401(k) accounts also include RMDs.

However, there are differences in how RMDs are applied depending on the type of retirement account you have.

A Roth IRA account includes RMDs that may be applied differently. Jason York/Shutterstock

When You Must Begin Taking RMDs

The law changed in December 2019.

The Setting Every Community Up for Retirement Enhancement Act (Secure Act) of 2019 determined that if you reached the age of 70 years and 6 months at any time in 2019, the prior RMD rules apply, which means you must have taken your first RMD by April 1, 2020. Those people who reach that age in 2020 or later must take their first RMD by April 1 of the calendar year in which they turned 72.

Amount I Must Withdraw in an RMD

In most cases, you can determine the amount of your RMD by dividing the balance of the account by the life expectancy factor determined by the IRS as of December 31 each year. The IRS has a complicated table that determines the life expectancy factor for individual account owners.

The life expectancy table was adjusted in 2020, just before the beginning of the pandemic. The new table extended the life expectancy for Americans, creating a longer period during which RMDs are required. That means your retirement account balance will be divided by a larger number, creating a smaller annual RMD than you would have taken prior to 2020.

The money will be included in your taxable income for the year in which you make the withdrawal. Some qualified distributions from Roth IRA accounts remain tax-free even upon distribution.

Since the RMD amount is different for individuals based on their current age and life expectancy, estimating an RMD will therefore be context specific. However, the amount is determined by a percentage of the balance on the account, and those percentages range between 3.5 percent and 4 percent of the balance annually.

An RMD must be taken from every account an individual has when they reach the age of 70 years and 6 months.

You can withdraw more than the required amount, but it will be taxed.

Returning the Distribution Amount to the Retirement Account

Individuals can do whatever they want with the RMD funds, including recontribute to the retirement account. That reinvested money will eventually be taxed again when the fund is depleted, as will any interest earned on the reinvested funds.

Unwilling to Take an RMD

The word “required’’ is in the title, so you must do this. If you do not, you will be taxed at 50 percent of the amount you were required to take out according to the IRS calculation.

Including 401(k) accounts, you can rollover your retirement accounts. Due

In Case of Death

When a defined contribution plan or IRA account owner dies, no matter the person’s age, the entire balance in the participant’s account must be distributed to beneficiaries within 10 years of death. That may not be the case if there is a surviving spouse or the beneficiary is a child who has not yet reached the legally mandated age of majority (18 or 19, depending on the U.S. state in which the child lives).

Options

You really do not have options regarding any accounts that include RMDs. Your options occur when you determine where to make contributions to retirement accounts.

That is why it is suggested you discuss your retirement income intentions with a financial advisor. That person can discuss your retirement spending intentions and determine the best plan for making retirement account contributions based on your income needs in retirement and any tax implications that are included.

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