I don’t know a single person who likes it when the government tells them what to do.
Unfortunately, if you’ve saved for retirement in a vehicle like an IRA or a 401(k), when you reach the age of 72*, that’s exactly what happens. At that point, savers are required to pull a specified amount from their tax-deferred account annually. Those withdrawals are known as Required Minimum Distributions or, because our industry can’t get enough acronyms, RMDs.
Because RMDs are often something that retirees (and future retirees) have heard about, but only in anger, I thought an RMD FAQ was in order.
What are Required Minimum Distributions? RMDs are mandatory withdrawals from qualified retirement plans, most commonly IRAs and 401(k)s, beginning the year an investor turns 72*. RMDs continue annually until the account is fully liquidated – which may not be until after the account owner has passed away and the funds distributed to their beneficiaries.
Can I take out more than my RMD? You absolutely can take more out – remember it’s a required minimum distribution.
Do Roth IRAs have RMDS? Generally, no. There are rare occurrences when inherited Roth IRAs have RMDs, but since the SECURE Act, that isn’t an issue for Roth IRAs inherited after the start of 2020.
How is an RMD determined? There are two factors that determine an RMD: the individual’s age and the value of the account at the close of the last trading day for the prior year. For example, an RMD for 2022 would be based on the closing value of the account on December 31, 2021. The age factor is based on a life-expectancy table published by the IRS.
So, if an investor turned 72 in 2022 and their prior year-end account value was $100,000, the account value would be divided by 27.4 (the age factor) to get an RMD amount of $3,649.64. The annual amount is determined early in the year, giving individuals and their advisors plenty of time to plan for the distributions.
When and how do RMDs need to happen? Basically, RMDs can be satisfied any time during the calendar year, up until the final seconds on December 31st (if you’re a client of mine, please don’t do that to Julie!) The distributions can be done either in one lump sum or periodically throughout the year. For those individuals taking their first RMD (turning 72 that year), they can actually delay their distribution until April 1st of the following year, though that means they will take two RMDs in one tax year, something most individuals choose to avoid.
I’ve heard about Roth conversions. Does that count towards my RMD? No, the distribution must come out of an IRA account to the individual as cash. A Roth conversion can be done by a person with an RMD, but the RMD money must come out of the account first before a conversion takes place.
Why are Required Minimum Distributions, you know, required? Simply put, taxes. The money in an IRA or 401(k) plan has never been taxed and the government wants their share. This is why a Roth IRA doesn’t have an RMD; that money was taxed before it reached the account and since qualified distributions from a Roth aren’t taxed, the government has nothing to gain.
Eh, I don’t want to take my money out. What happens if I don’t? In short, not satisfying an RMD is a problem. The portion of an RMD not taken in a given year incurs a 50% penalty at income tax time, an extreme hit for individuals who fail to meet this requirement.
There are, of course, additional questions that can arise when an individual reaches RMD age, but these are the most common I receive. If you have a specific question you’d like an answer to, please reach out to me and I’ll be happy to help.
* - There is a bill in Washington that would raise the RMD age from 72 to 75. That may or may not become law, but currently 72 is the age that counts.
Photo by Vlad Sargu on Unsplash