If you have ever heard the term ‘RMD’ in financial conversations and wondered what it means, or if it applies to you, you are in the right place! In this blog post, we will break down everything you need to know about Required Minimum Distributions (RMDs) including:
- What is a Required Minimum Distribution?
- The types of retirement accounts affected
- Age at which making withdrawals are required
- How RMDs are calculated
- IRS Withdrawal deadlines
- Tax implications of withdrawals
- Key exceptions
Let us dive in!
What is a Required Minimum Distribution?
A Required Minimum Distribution is the minimum amount of money you must withdraw each year from certain types of retirement accounts after reaching a specific age, as mandated by the IRS. RMDs ensure that assets in tax-advantaged retirement accounts do not grow indefinitely without being taxed. You may start sooner than the IRS specified age and/or withdraw more than the minimum required amount.
Which accounts are impacted by RMDs?
RMDs apply to the following types of retirement accounts:
- Traditional IRAs
- SEP IRAs
- Simple IRAs
- SARSEP IRAs
- 401(k) Plans (excluding Roth 401(k)s for owners after 2023)
- 403(b) Plans
- 457(b) Plans
- Profit Sharing Plans
- Inherited IRAs or Retirement Accounts (both Roth and Traditional, depending on the beneficiary’s status and applicable rules)
Note that RMDs do not apply to Roth IRAs (during the account owner’s lifetime).
What are the age requirements for an RMD?
The age at which you must start taking RMDs depends on your birth year:
- If you were born between 1951 and 1959, RMDs must start at age 73
- If you were born in 1960 or later, RMDs must start at age 75
Your first RMD is due by April 1 of the year after you reach the required age, and all subsequent RMDs must be taken by December 31 each year.
Also know that many Americans take withdrawals from their retirement accounts well before the specified age for an RMD. The retirement age to take withdrawals and avoid tax penalties from a tax-deferred retirement account is 59 and ½ years or later (some exceptions apply to this age requirement, and you will want to consult with a tax advisor to determine if they are applicable to your situation).
How are RMDs calculated?
RMDs are calculated by dividing the balance of your retirement account on December 31 of the previous year by a number called your life expectancy factor, which is provided in IRS tables. These tables estimate how many years you are expected to live based on your age.
As an example, if your prior year end retirement account balance was $100,000 and your life expectancy factor is 25, your RMD for the year would be $4,000 ($100,000/25).
More information on the life expectancy factor and associated tables can be found here.
Also know that some retirement account providers offer calculators that may be helpful as well. Just know the account holder is responsible for taking the correct amount for the RMD.
What are the withdrawal deadlines?
- Your first RMD must be taken by April 1 of the year following your required age (If you were born between 1951 and 1959, RMDs must start at age 73, and if you were born in 1960 or later, RMDs must start at age 75). After your first RMD, subsequent RMDs must be made every year by December 31.
What are the tax implications?
RMDs are generally taxed as ordinary income at your current tax rate. In practice, this means the amount you withdraw will be added to your taxable income for the year.
Exceptions: If you made non-deductible contributions to your retirement account, a portion of your RMD may not be taxable. Roth accounts are also generally exempt from taxes (except for inherited Roth accounts).
It is important to note that penalties can arise if you fail to withdrawal your full RMD by the deadline. The IRS may impose a 25% excise tax on the amount you were required to take but did not or 10% if you correct the error within two years. You will need to file Form 5329 and file a letter of explanation to see if you may receive relief from the penalty. Always consult with your tax or legal advisor to ensure you are abiding by all required RMD requirements, rules, and guidelines.
What are the key exceptions to RMDs?
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Roth IRAs - Do not require RMDs during the account holder’s lifetime because contributions are made with after-tax dollars and qualified withdrawals are tax-free. However, beneficiaries who inherit a Roth IRA must take distributions according to the rules for inherited accounts.
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Still Working – If you are still working, you might not need to take RMDs from your current employer’s retirement plan even after reaching the RMD age.
Note that this exception applies only if:
- The current employer permits it
- You do not own more than 5% of the company you currently work for
- It does not apply to IRAs or plans from previous employers
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Roth 401(k)s – Starting in 2024, Roth 401(k)s are treated like Roth IRAs and no longer require RMDs during the account holder’s lifetime. However, beneficiaries who inherit a Roth 401(k) are still subject to inherited account RMD rules.
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First RMD Year Delay – You can delay your first RMD until April 1 of the year following the year you reach the RMD age. As mentioned above, you will want to consult with a tax advisor regarding timing, as delaying will require you to take two RMDs in the same calendar year (which theoretically could push you into a higher tax bracket).
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Rollover Exception – Direct rollovers from a tax-deferred account to a Roth account or another tax-advantaged account are not considered RMDs. You must take the RMD for the current year before executing a rollover.
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Qualified Charitable Distributions (QCDs) – Distributions made directly from your IRA to a qualified charity (up to $100,000 per year) can count towards your RMD but are not taxable. This exception becomes available at age 70 1/2, even If RMDs are not yet required of you.
Putting it all together:
Understanding Required Minimum Distributions (RMDs) is essential for anyone with tax-advantaged retirement accounts that is not already taking withdrawals or withdrawing the minimum required amount. These mandatory withdrawals ensure that deferred taxes are eventually paid, and they can have significant financial and tax implications. By knowing these rules, applicable accounts, who they apply to, the calculation methods, and important deadlines, you can better manage your withdrawals and avoid costly penalties. Additionally, taking advantage of exceptions, such as charitable distributions or employer-based deferrals, can help optimize your financial strategy. Please consult a tax or financial advisor to create a plan tailored to your unique situation and goals.
Key Takeaways:
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What is a Required Minimum Distribution (RMD)? – RMDs are mandatory yearly withdrawals from specific retirement accounts after reaching a certain age as determined by the IRS.
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Affected Accounts: Traditional IRAs, SEP IRAs, SIMPLE IRAS, 401(k)s, 403(b)s, and similar plans require RMDs, but Roth IRAs do not (during the owner's lifetime).
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Age Requirements: RMDs start at age 73 for those born 1951–1959, or age 75 for those born in 1960 or later.
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RMD Calculation: Divide the previous year-end account balance by a life expectancy factor from IRS tables.
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Deadlines: First RMD by April 1 of the year after reaching the required age; subsequent RMDs by December 31 each year.
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Tax Implications: RMDs are taxable as ordinary income, and penalties for missed withdrawals can be severe.
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Exceptions:
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No RMDs for Roth IRAs during the owner’s lifetime.
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Still-working exception for some employer plans.
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Qualified charitable distributions reduce taxable income and count toward RMDs.
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*This material is intended only as general information for your convenience and should not in any way be construed as investment or tax advice by ShareBuilder 401k. The owner/participant should consult with their tax advisor regarding any specific tax strategies. *