If you’ve reached a certain age, you may have recently received a letter from your bank, brokerage firm or mutual fund company, informing you that you’ll have to take an RMD before year end – and they may have even told you what the amount is.

So what is an RMD? Well, let’s start by remembering that all the money you contributed to your 401k plan at work, or to your SEP IRA or regular IRA, was done with pre-tax dollars – that is, income that you put into the account before you paid any tax on it to the IRS.

The investment earnings on those salary deferrals or IRA contributions – interest, dividends and capital gains – were also never taxed – they just continued to accumulate in your account over the years.

But… the 401k, SEP IRA and IRA are not tax-free retirement accounts, they are tax-deferred accounts.

So after letting those contributions – and the income they earned – grow without tax – often for 40 years or more, the IRS wants to start collecting the taxes that it deferred. But they’ve graciously allowed you to wait until you reach age 70 ½, or if later, the year in which you retire, before doing so.

There is an exception to the age 70 ½ rule – and that’s if you’re either a 5% or greater owner of the business that sponsors the retirement plan, or if the RMD is for an IRA, then your withdrawals must start the year you turn 70 ½ even if you’re still working.

So, we know what the RMD is – it’s a minimum amount that the IRS requires you to withdraw from your retirement account generally starting at age 70 ½, so that they can tax it.

How is your withdrawal or distribution taxed?
Well, remember that the salary contributions were made with income that was never taxed, and the earnings on those contributions were also not taxed when they were earned. So it makes sense that the IRS would tax the withdrawal as income, at ordinary income rates. When you request your RMD from your bank or brokerage firm, they’ll send you a form 1099-R, which you’ll use to report that distribution as income on that year’s tax return.

How is your distribution amount calculated?
It’s pretty simple, really. We divide the prior year’s balance of the retirement plan or IRA account by a divisor – called a life expectancy factor – that we look up in tables on the IRS website or in IRS Publication 590.

There are three different tables, and the one to use depends on your personal situation.

The Joint and Last Survivor Table is used if the only beneficiary of your account is your spouse, and your spouse is more than 10 years younger than you;

The Uniform Lifetime Table is used if your spouse is not the only beneficiary, or if your spouse is not more than 10 years younger than you; and

The Single Life Expectancy Table is used by a beneficiary of an account.

Here’s a simple example, for an unmarried person who’s 72 this year. The balance in their IRA account at the end of last year was $400,000. Their birth date is March 1st, 1940. So we’ll divide 400,000 by the divisor that we look up in the IRS’s Uniform Life Table, which for a 72 year old is 25.6. The result is $15,625 and that is the minimum that must be withdrawn before December 31st.

So, what’s the deadline for taking your distribution?
You’re required to take your first RMD in the year you turn age 70 ½. Figuring when this is, isn’t as difficult as it sounds – if your birthdate is January through June, then your distribution has to be taken in the year you turn 70 – no later than December 31st. If your birthday is in July through December, then you can take your distribution in the year you turn 71, no later than December 31st.

A couple of examples may help.

Let’s say your birthday is May 15th, and this year you turned 70. Well, then you turn 70 ½ on this November 15th, and you have to take your distribution before December 31st of this year.

Now, let’s say your birthday is October 15th, and this year you turned 70. Well, then you turn 70 ½ on April 15th next year, and you have to take your distribution before December 31st next year.

And one last kink – you can actually delay your first RMD until April 1st of the year following the year you turn 70 ½. But then you would have to take two distributions in one year, and that generally doesn’t make sense.

What if you have more than one retirement account subject to RMDs?
The IRS requires you to calculate the RMD separately for each IRA that you own. But you can withdraw the total amount from any one or more of the IRAs – your choice.

The same holds true for 403(b) account owners.

But RMDs required from other types of retirement plans, like 401k and 457b plans, have to be taken separately from each of those accounts.

Can I take out more than my required minimum distribution?
Of course! The IRS has been waiting for years – often decades – for the opportunity to tax your deferrals or contributions into those accounts, and the income on them, and so they would love you to take the money out faster. Bigger withdrawals mean more tax revenue for them.

What if I don’t withdraw enough?
Not a good thing! If you don’t take your RMD, don’t withdraw the full required amount, or don’t withdraw the RMD amount by the applicable deadline, the amount you should have withdrawn but didn’t is taxed at 50%. This is on top of the regular income tax that will be due when you do take the distribution.

So it’s important to keep on top of your RMD calculations and the timeliness of the distributions.

What if I inherited an IRA or retirement plan account?
RMDs for inherited IRAs and retirement plans are treated differently than those taken by the original account owner. We’ll cover the differences in a separate video, so stay tuned.

So in summary, RMDs are really nothing more than the IRS collecting the taxes on income and earnings that it allowed you to defer, and basing the collection schedule on your life expectancy.