Required Minimum Distributions (RMDs): How on Earth Do They Work?

Have you ever used a coupon for 50% off one item, but in teenie-tiny text it said, “… when you spend $100 or more?” Required minimum distributions (RMDs) are kind of like the coupons of the retirement world.

Retirement accounts come with a lot of perks, like compound interest and tax benefits. But one tradeoff of receiving these perks is that you must withdraw a certain amount of money.

A required minimum distribution is the amount you have to withdraw from your retirement account each year once you reach age 70 ½. And like a coupon, it has some fine print you’ll want to read. Retirement accounts might as well read, “Save more quickly and receive tax benefits … when you withdraw $X or more.”

What Exactly Are Required Minimum Distributions?

Required Minimum Distributions in a Nutshell

A required minimum distribution is the amount you must withdraw from your retirement account by April 1st of the calendar year after you turn 70 ½. (Although if certain legislation goes into effect at the end of 2019, that age would be bumped up from 70 ½ to 72.) After that, you withdraw by December 31st every year.

For example, let’s say you turned 70 ½ in 2019. You should withdraw your required minimum distribution by April 1, 2020. The next time you’ll be required to take out money is December 31, 2021.

You could discover that this money helps you live a better life from year to year. Or you might be thinking, “Wait, the government is forcing me to take money out of my retirement account? That’s ridiculous!”

Yes, it can be annoying if you don’t need that money anytime soon. But this might cheer you up—if you don’t need that money to live right now, think of everything you can do with a few extra bucks. Take a trip to Italy and eat all the pasta and pizza your heart desires. Give the money to a grandchild to pay for their college. Be super responsible and re-invest the money if that’s your thing. Hey, you set aside this money for a reason.

Required Minimum Distribution Rules

You also might be thinking, “Uh-oh, I have to withdraw money… How much money are we talking here?” There’s a simple (well, simple-ish) way to calculate your required minimum distribution.

First, take the balance of your retirement account from December 31st of the year you turned 70 ½. Then, look at the IRS RMD table. Find the age you’ll be on your birthday this year and the corresponding distribution period. (This is basically the estimated number of years you have left to live. That’s surreal to look at, isn’t it?) Finally, divide the account balance by the distribution period.

Here’s an example: Margie turned 70 ½ in 2019, so she’ll turn 71 in 2020. She has $250,000 in a traditional IRA. Looking at the distribution table, the distribution period of a 71-year-old is 26.5 years. She’ll divide 250,000 by 26.5. On April 1, 2020, her required minimum distribution will be $9,433.96.

What if you’re married to someone who’s a good deal younger than you are? If your spouse is at least 10 years younger, use Table II on the IRS website. Find your combined distribution period on the table, then divide that your account balance by that number.

Again, we’ll look at Margie. Let’s say Margie is turning 71, but she’s married to someone who is 59. Let’s go to the chart!

The new distribution period is 27.9. Margie will now divide $250,000 by 27.9 and—tada!—her required minimum distribution has dropped to $8,960.57.

If you miss a required minimum distribution payment, pay too little, or pay late, your penalty is 50% of the amount you didn’t pay. If Margie wakes up one day in September and realizes she never paid the amount in April, she won’t just have to pay the $8,960.57. She’ll also have to pay $4,480.29 on top of it. Yikes!

There’s no need to be nervous about missing a payment, though. If you connect with a professional, they can help you set up automatic payments so you’ll never be penalized.

Which Accounts Have Required Minimum Distributions?

All employer-sponsored retirement accounts, including traditional and Roth 401(k) plans, 403(b) plans, 457(b) plans, and profit sharing plans, have required minimum distributions.

What if you save with an IRA? Most of these accounts call for required minimum distributions, including traditional IRAs, SIMPLE IRAs, SEPs, and SARSEPs. There is one big exception: the Roth IRA. You do not have required minimum distributions from a Roth IRA, unless you are beneficiary who has inherited a Roth IRA.

What Are the Aggregation Rules?

It’s not uncommon to have more than one retirement account. Maybe you have one employee-sponsored account and one IRA, or a 401(k) with one employer and a 403(b) with another. You might be wondering if you can simplify your life and just withdraw the combined amount of required minimum distributions from one account instead of two or more.

Well… maybe. It depends on the type of accounts you have:

  • IRAs: You can aggregate your IRAs, even SEP and SIMPLE IRAs. Let’s say you have two traditional IRAs and one SEP IRA. Calculate the required minimum distribution for each, and you have the option to withdraw the combined amount from just one of those accounts or from multiple.
  • 403(b)s: You can also aggregate 403(b)s. If you have three 403(b)s, you can withdraw the money from any one of them.
  • Other employer plans: You cannot aggregate plans like 401(k)s or profit sharing plans. You must withdraw required minimum distributions from each account individually.

Are these just too many balls for your mind to juggle? Remember, you can always consolidate all your pre-tax funds into one IRA account to keep everything in one place and eliminate confusion.

There are several ways to go about required minimum distributions, and you can reach out to us directly to talk about consolidation, figuring out how much you’ll pay, or learning more about how required minimum distributions work.

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investing for retirement ebook ipad - McClain Lovejoy
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