If you are approaching or already in retirement, then you are probably at least somewhat familiar with “required minimum distributions” (RMDs).  The term applies to the distributions that the Internal Revenue Service (IRS) requires you to take from a retirement account.  The rules surrounding these distributions have changed several times in just the past few years.  The following Q&A guide will get you current and help you make wise decisions for a secure retirement.

What is an RMD?

A required minimum distribution is the minimum amount that the IRS requires you to take from your retirement accounts once you reach age 72.  You might remember that, under the old rules, the IRS required these distributions beginning at age 70 ½.   The change was included in the SECURE Act which was passed in 2019.

What if I am still working at age 72?

If you are still working, you do not own more than 5% of the business for which you work and you have a retirement account with your employer, you may defer taking an RMD from your account in your employer’s plan (e.g. 401(k) or 403(b)) until April 1 of the year after you retire.  This exception does not apply to your other retirement accounts.

What if I own my business?

If you own 5% or more of the business sponsoring your retirement account, you must take the RMD once you reach age 72, regardless of whether you are retired.

What types of retirement plans require minimum distributions?

The IRS states that the RMD rules apply to all employer-sponsored retirement plan, including 401(k), 403(b), and 457 plans.  They also apply to traditional IRAs and IRA-based plan such as SEPs, SARSEPs, and SIMPLE IRAs.  The rules also apply to a Roth 401(k) plan, but not Roth IRAs.

When do I have to take my RMD?

You have to take your first RMD for the year in which you turn age 72.  However, you can postpone this distribution until April 1 of the following year.  If you do this, you will be required to take two distributions in that year.  One will be the amount calculated for the prior year (age 72) and one will be calculated for the current year (age 73).  All future RMDs must be taken no later than December 31.

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How are my RMDs calculated?

The IRS requires you to take distributions annually from your retirement accounts in a manner that would eventually empty them at the end of your life.  The IRS does this by requiring you to divide the balance in your retirement accounts as of December 31 of the prior year by a life expectancy factor.

So, if you are age 72, your life expectancy from the IRS tables is 15.5.  If the value of your retirement account on December 31 was $1 million, then your RMD for the next year is $64,517 ($1 million/15.5).

There are different factors for various beneficiaries of retirement accounts.  You can learn more on the IRS website.

What if I have multiple retirement accounts?

You have to calculate the RMD for each retirement account.  However, you can take the total RMD for all your IRAs from one or more of them and you can do the same thing with all of your 403(b)s.  However, you have to take RMDs from other retirement accounts such as 401(k) plans separately from each account.

What is the tax treatment of an RMD?

Your RMD will be subject to federal, state and (relevant) local income taxes.  However, if you have made after-tax contributions to the plan, those may be recovered tax free.  Also, distributions from a Roth IRA are not subject to taxation.

What happens if I don’t take my RMD?

If you fail to take your full RMD by the deadline (December 31), the amount not withdrawn is subject to an excise tax of 50%.  For example, if your RMD is $50,000 and you only withdraw $30,000, the penalty is $10,000 (50% of $20,000 ($50,000-$30,000)).  Clearly, for a secure retirement, you want to avoid this.

Should I ever take more than my RMD, if I don’t need the funds?

Actually, there are circumstances when this can make sense.  It really depends on your tax circumstances.  If you incurred high medical expenses, made large charitable contributions or had other substantial itemized deductions that together exceed your personal exemption, then taking a larger distribution from your retirement account might make sense.  The extra income would be reduced by the large deductions.

If you are trying to move funds into a non-retirement account for eventual transfer to your heirs, taking a larger distribution than you need could be attractive.  This is particularly true, if your tax rate is lower than those of your heirs.

You could also take a larger distribution from an IRA (i.e. greater than the RMD) and convert some of it (up to the limit) into a Roth IRA.  Remember, that funds in a Roth IRA grow tax free and they are not subject to the RMD rules.

Be sure to consult with your tax professional before taking any action, as the rules are complex.

What about my non-deductible contributions to my retirement account?

These after-tax contributions can be withdrawn tax free.  However, it is important to keep careful records of the contributions.  The RMD calculations will require you to segregate your non-deductible contributions from your deductible contributions

Is there a way for me to make a charitable donation with my RMD?

Yes, and this can be very attractive for those who are charitably inclined.  If you do not need the funds you are required to take from your retirement account, you can instead make a direct distribution of your RMD to a qualified charity.  This is called a qualified charitable distribution (QCD)

The QCD is a win-win strategy.  The charity benefits from your contribution of your distribution from your retirement account.  You benefit, because you will not be taxed on the distribution.  Given that most American are no longer able to deduct their charitable donations, the QDC offers an equivalent tax benefit.

Making a QDC requires some planning.  You must have the custodian of your retirement account make the distribution directly to the charity.  You must also report the transaction properly on your tax return.  You can direct up to $100,000 annually of your IRA to charity.  Also, you can do this as early as age 70 ½.

Am I required to take a distribution in 2020?

No.  Because of the global pandemic caused by COVID-19, Congress passed the CARES Act.  This legislation waives RMDs in 2020.  If you have already taken your RMD for 2020, the IRS will allow you to  roll those funds back into the account.

Final Thought

The rules surrounding RMDs are complicated.  So do your homework and consult a tax professional.  Planning for your RMDs is part of a secure retirement.