Ideally, you want to let your tax-sheltered retirement savings grow as long as possible before you start depleting it. Once you reach your 70s, however, the IRS requires you to begin taking withdrawals whether you need the money or not.
Known as required minimum distributions (RMDs), these withdrawals come with tax implications as well as hefty penalties if you fail to take them on time. While we can’t advise you on managing the tax implications—but encourage you to discuss the subject with a licensed tax advisor—we can help you avoid some pitfalls and make the process easier on yourself.
Below are the answers to some essential questions you should be asking about your retirement portfolio and RMDs.
Who has to take RMDs?
If you own a pre-tax retirement account such as a 401(k), 403(b) or a traditional, SEP or SIMPLE IRA, you’ll need to start taking required minimum distributions the year after you turn 72.
If you inherited an IRA from someone other than your spouse prior to December 31st, 2019, you’ll be subject to required minimum distributions as well.
If you’re still working at age 72, have a retirement account with your employer, and don’t own 5% or more of the company, you don’t have to take any RMDs until April 1 of the year after the year you retire.
Note that RMD’s are not required from a Roth IRA, but do apply to the Roth sub-account of a qualified plan like a 401(k).
Why are these withdrawals necessary?
Most retirement plans are tax-deferred, meaning taxes are not applied on the income as it is earned and set aside into the plan, and taxes are not applied to most earnings generated within the plan. Taxes are paid when distributions are made, and RMD’s are the means to ensure that those distributions do at least begin in your lifetime.
When do I have to start?
The IRS lets you choose between taking your first distribution by the end of the year you turn 72 or by April 1 of the following year. All future RMDs must be made by Dec. 31 of each year.
While it might be tempting to delay your first distribution as long as possible, consider that if you wait, you’ll be taking two payments in the same tax year, since your second RMD will be due by Dec. 31. Consult your tax expert about whether it’s preferable to spread your first two RMDs out over two years instead.
What happens if I miss the deadline?
The penalty for failing to take your required minimum distributions in time is a painful 50 percent of the amount you should have withdrawn.
How much do I have to withdraw?
Calculate your required minimum distribution by dividing the fair market value of your account by your life expectancy. Use the value your account held on Dec. 31 of the previous year, and use the IRS’s Uniform Lifetime Table to determine your life expectancy.
Your IRA custodian will typically perform this calculation for you, and let you know how much you need to distribute in the current tax year.
What if I have more than one IRA?
RMD amounts are calculated individually by account, but do not necessarily need to be taken from any particular account. So long as you take the sum total amount that is required as a distribution, then you have met the requirement, whether that distribution is from multiple accounts or just one. For this purpose, IRA and employer plans are grouped separately. You can consolidate across IRA plans, but cannot use a 401(k) distribution to meet IRA based RMD requirements, and visa-versa.
How will this affect my retirement investment?
Some retirement accounts are more liquid than others. Depending on the nature of your investments, you may need to plan ahead to ensure your accounts maintain enough liquidity to accommodate your required minimum distributions.
Another thing to keep in mind is that if your investments are producing a 5 percent annualized return, you can take your RMDs from those earnings without having to liquidate plan assets until about age 85.
Do I have to spend my RMDs?
If you don’t need the money to live on, you can always choose to stash your distributions in a taxable savings account and let them continue to grow.
Required minimum distributions are a fact of life for everyone with a tax-deferred retirement account. By planning ahead for them, you can avoid extra costs and make the process as painless as possible.
This page has been updated to reflect tax law changes included in the SECURE Act of 2019.