What are Required Minimum Distributions or RMDs?

Required Minimum Distributions

Perhaps you’ve heard of Required Minimum Distributions, or the acronym, RMD and have wondered, “What exactly is that?” Well, you’re not alone.

Being in the financial services industry, it’s easy for me to take these terms for granted and assume everyone just knows exactly what they are, but the reality is, unless you’re dealing with these things on a regular basis, it’s hard to keep up with all the terminology.

We often spend a lot of time determining how much is needed to retire to create a paycheck that we forget we may get a raise once we reach age 70 1/2. This could have a huge tax impact on a taxpayer’s situation. So today I want to shed some light on Required Minimum Distributions.

What are Required Minimum Distributions or RMD’s?

A Required Minimum Distribution, or RMD, is generally a minimum amount a retirement account owner must take out once they reach age 70 1/2.

There are some exceptions to this. For example, if a person is still working beyond age 70 1/2 and they have a workplace retirement account like a 401k, then they do not have to take the RMD from the 401k. Once this person retires, then RMDs must be taken from that 401k plan.

If they have an IRA, they must take it at age 70 1/2 whether they are working or not. So, essentially, all IRA account owners must start taking minimum distributions from their IRA at age 70 1/2 regardless of whether they are working or not.

RMD’s must be taken beginning in the year you turn age 70 1/2, but for your very first withdrawal, you have up until April 1st of the year after you turned age 70 1/2. All other withdrawals must occur each and every year, and must be taken out by December 31st.

How Are Required Minimum Distributions or RMD’s Calculated?

RMDs are calculated for each IRA that a person owns, and is based on the December 31st balance of the previous year. The IRS has a life expectancy factor, which takes a number that gets divided into an owner’s IRA account balance. That number becomes your RMD.

For example, if you are age 70 1/2, and your December 31st value was $1,000,000, then you must divide 27.4 into that amount, which gives you a result of nearly $36,500. Here are the available IRS worksheets to determine your RMD amount.

What Happens if You Don’t Take Your Required Minimum Distribution or RMD?

But what if you don’t want to take your IRA withdrawal? After all, why start withdrawing from your IRA, especially if you don’t need the money?

Well, here’s why:

If an IRA account owner decides not to withdraw their RMD, withdraws less than the full amount of the RMD, or doesn’t withdraw the RMD by the deadline, the amount not withdrawn is taxed at 50%. Ouch! A 50% penalty. Uncle Sam makes sure you don’t mess with him on this one, and the last thing you want to do is owe the IRS back taxes!

If you realize you have not taken the right withdrawal, you should file Form 5329 with your Federal tax return. So there you have it. I hope this sheds a little more light on RMDs.

For more information, check out these RMD FAQ’s at the IRS website.

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