Retirement accounts can allow investments to grow for decades, but tax-advantaged treatment does not always mean money can remain untouched indefinitely. Federal law requires many owners of traditional retirement accounts to withdraw a minimum amount each year after reaching a specified age. These withdrawals are called required minimum distributions, or RMDs.
Understanding the rules is important because missing a required withdrawal can lead to an excise tax.
Which Accounts Are Covered?
RMD rules generally apply to traditional IRAs, SEP IRAs, SIMPLE IRAs and many employer-sponsored retirement plans, including 401(k), 403(b) and 457(b) plans.
Roth IRAs owned by the original account holder are not subject to lifetime RMDs. However, beneficiaries who inherit Roth IRAs may face distribution requirements.
The rules can differ depending on the account type and whether the owner is still working.
When Do Withdrawals Begin?
Under current federal rules, many retirement account owners begin RMDs at age 73. The first distribution can generally be delayed until April 1 of the year following the year the owner reaches the applicable starting age.
That delay has a consequence: the second RMD is still due by December 31 of that same year. Taking two distributions in one calendar year can increase taxable income, so retirees should consider the timing before using the delayed deadline.
Some workplace-plan participants who are still employed may be able to delay RMDs from their current employer's plan, depending on the plan rules and ownership status. This exception generally does not apply to traditional IRAs.
How the Amount Is Calculated
The RMD is generally calculated by dividing the account balance from the previous December 31 by an IRS life-expectancy factor. The appropriate factor depends on the account owner's circumstances and the applicable IRS table.
Different rules may apply when a spouse is the sole beneficiary and is more than ten years younger than the account owner.
An investor with several traditional IRAs can generally calculate the RMD for each IRA and withdraw the combined amount from one or more of those IRAs. Employer-plan RMDs generally must be calculated and withdrawn separately under the relevant plan rules.
What Happens If an RMD Is Missed?
Failing to withdraw the full required amount can result in an excise tax. The standard tax is generally 25 percent of the shortfall, but it can be reduced to 10 percent if the shortfall is corrected within the correction window and the relevant requirements are met.
The IRS may waive the tax in certain circumstances when the shortfall resulted from reasonable error and reasonable steps are taken to correct it.
Planning Ahead
Retirees should not wait until the end of December to check their RMDs. Account balances, multiple custodians, inherited accounts and investment transactions can complicate the calculation.
A withdrawal may also affect taxable income and other income-related costs. Planning distributions earlier in the year can provide more time to correct mistakes and coordinate with other retirement income.
The Bottom Line
RMDs are a federal tax requirement for many retirement accounts, not an optional investment decision. Knowing when distributions begin, how the amount is calculated and which accounts are covered can help retirees avoid unnecessary penalties and plan their taxable income more carefully.
This article is for informational and educational purposes only and should not be considered personalized financial, investment, retirement or tax advice.
