Answers to questions about required minimum distributions
What to do when your retirement account tax holiday ends
When it comes to taxes, IRAs and 401(k) retirement accounts offer a pretty good deal. When you put some of your paycheck into those accounts, that money isn’t counted toward your taxable income.
And that’s not the only perk: your earnings on those accounts can grow without being reduced by taxes. You reduce your taxable income and increase your retirement savings while the Internal Revenue Service (IRS) sits idly by. What’s not to like?
But this great deal comes with an expiration date.
When you reach age 72, the IRS requires you to annually make a withdrawal from your tax-deferred retirement accounts. Please note, that prior to the passage of the SECURE Act, enacted on January 1, 2020, the beginning age for required minimum distributions (RMD) was 70 ½. When you take money out of a retirement account, you must pay income taxes on the amount you withdraw. RMD rules define how much you must take out, and when you need to make your withdrawal.
The RMD world can be complicated by calculations, variations and exceptions. It’s taxes, right? No one ever said it was going to be simple. But you’ve dealt with taxes your whole life, so with a little effort you can definitely handle this.
Why do RMDs exist?
If you’ve been setting aside part of your earnings in an IRA or 401(k) or other tax-advantaged retirement account, you haven’t paid income tax on those dollars. The government lets you delay paying taxes, but RMDs are how the government ensures you’ll eventually be taxed.
Which retirement accounts are subject to RMD rules?
According to the IRS rules, if you have any of these plans, you’re required to take annual RMDs:1
- 401(k), 403(b) and 457(b)
- Traditional IRAs, SEP and SARSEP
- SIMPLE IRAs and Roth 401(k) accounts
Any investment or savings accounts you fund with money you’ve already paid taxes on are not subject to RMD rules, like Roth IRAs.1
Withdrawal rules differ for IRAs and 401(k)s. If you have more than one IRA, you can total your IRA RMDs and, if you wish, withdraw that amount from just one account. For 401(k)s, a separate RMD must be calculated for and withdrawn from each of your 401(k) accounts.2
When do I need to start taking an RMD?
You must start taking RMDs when you turn 72 or continue to take RMDs if you reached age 70 ½ prior to January 1, 20201
There is one exception: people still on the job after age 72 usually may delay taking RMDs from their employer sponsored plan until they retire.2
You may want to check with the IRS or talk to a tax advisor for more details.
Your first required withdrawal doesn’t have to be made until April 1 of the year after you turn 72. After that first withdrawal, the IRS requires you to take RMDs by December 31 each year.
Here is an example
Betty turns 72 on Nov. 1, 2021. Betty has until April 1, 2022, to take her 2021 required minimum distribution. If she waits until then, she’ll also be required to take her 2022 distribution by December 31, 2022.
How much am I required to withdraw?
Your RMD is based on the value of your account on December 31 of the previous year.1 An RMD for 2021, for example, is based on your account value as of December 31, 2020.
The withdrawal amount is calculated by dividing your account value by a number based on your age. In IRS terms, that’s called the life expectancy factor — which can be found in the IRS’s Uniform Lifetime table.3, 4 Because the factor decreases as you age, the amount of your RMD will grow as you get older.
Here’s an example of how the life expectancy factor works:
- If your IRA balance at year-end is $1 million and you’re 72 years old, your life expectancy factor is 25.6 , according to the IRS.
- Divide your balance by 25.6 ($1,000,000/25.6 ), and that equals $39,062.50, which is your RMD amount.
An 80-year-old with an identical balance would use the life expectancy factor of 18.7, which would result in a $53,475.90 RMD. For a 90-year-old, the RMD on a $1 million balance would be $87,719.20.
Exception alert: If your spouse is the sole beneficiary of your retirement account and is 10 or more years younger than you, the life expectancy factor should be obtained from the IRS Joint Life Expectancy table.4
You can always withdraw more than the RMD amount, but any additional withdrawal won’t count toward future RMDs.
Is there a penalty if I don’t take an RMD?
The penalty for not taking an RMD is severe: 50 percent of the amount that should have been withdrawn.1
If, for example, you did not take a required distribution of $10,000, your penalty would be $5,000.
To get the penalty waived, you have to convince the IRS that your failure to take a distribution was the result of a mistake, and you’ll need to show proof that you’re working to correct the error.
Can I invest my RMD in another retirement account?
The SECURE Act eliminated the age 70 ½ maximum age limit for making an IRA contribution. IRS rules do not allow you to put your RMD into another tax-advantaged retirement account via a direct transfer. However, you can take your RMD, pay the tax and reinvest in an IRA if you have earned income for the year in which you make the contribution.
RMDs: A part of retirement that no one looks forward to, but help is available
There are many great things about retirement.
Unfortunately, RMDs typically aren’t one of them. The rules are complicated. The penalties are significant. And there’s math. But there’s good news — help is available!
Financial institutions that offer IRA or 401(k) accounts often notify their customers when an RMD is due. Many provide a calculation of how much needs to be withdrawn. If you’re approaching age 72 , you may want to check with your IRA or 401(k) provider to find out what assistance they offer.
You also will want to look at the bigger picture and consider:
- How will RMDs affect your financial situation?
- How will your withdrawals affect your investment portfolio?
- Will the increased income from an RMD put you into another tax bracket?
- Could the additional income affect your Medicare premiums and the tax you pay on Social Security income?
It’s a good idea to discuss these questions with a financial professional, who can help you develop a strategy to prepare for RMDs. And your tax advisor can help you avoid unpleasant surprises at tax time.
With a little knowledge and some planning, you can get ahead of the game and be prepared when “RMD Day” comes.
1. Retirement Plan and IRA Required Minimum Distributions FAQs, Internal Revenue Service (IRS), September 19, 2020.
2. Individual Retirement Arrangements (IRAs), Internal Revenue Service (IRS), November 12, 2020.
3. IRA Required Minimum Distribution Worksheet, Internal Revenue Service (IRS), As of April 7, 2020.
4. Distributions from Individual Retirement Arrangements (IRAs), Internal Revenue Service, Publication 590-B (2019), updated February 24, 2020.
This information is a general discussion of the relevant federal tax laws provided to promote ideas that may benefit a taxpayer. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. Taxpayers should seek the advice of their own advisors regarding any tax and legal issues specific to their situation.
By Securian Financial