What Every Retirement Saver Should Know About Required Minimum Distributions

By Emily Guy Birken on 10 January 2018 0 comments

You may be aware of the fact that contributing money to a tax-deferred retirement account, like a traditional IRA or a 401(k), means you get to put money aside before it is taxed. This reduces your current tax burden and gives you a great incentive to save for retirement.

Unfortunately, Uncle Sam will eventually want his cut of that money. That's where required minimum distributions (RMDs) come in.

The good news is that you have until age 70½ before you have to worry about RMDs. But it's still important to understand how RMDs work and what to expect before you get to that age milestone.

What is a required minimum distribution?

Deferring taxes is great for the taxpayer, but the IRS can't afford for taxpayers to defer their taxes indefinitely. Individuals with tax-deferred retirement accounts have to actually withdraw money — and thereby pay taxes — or else those taxes will never get paid.

Everyone holding a 401(k) or IRA account (with the exception of Roth IRAs) must begin withdrawing money from those accounts during the year they reach age 70½. This ensures that account holders have enough time to allow their money to grow without permanently sheltering their money from federal taxes.

The IRS has established minimums that you must withdraw each year after reaching age 70½. If you fail to withdraw the proper RMD, you face a stiff penalty: The IRS will take 50 percent of the amount you should have withdrawn.

Calculating your RMD

It's also important to note that you are responsible for calculating and withdrawing the correct RMD each year — and the calculations aren't necessarily easy. Even if the custodian of your IRA or 401(k) does the math and paperwork for you, you are the responsible party in the IRS's eyes.

So how do you figure out your RMD? You need to start with three pieces of information:

  1. Your date of birth.

  2. The balance of each tax-deferred account as of Dec. 31 of the year before the year in which you turn 70½.

  3. The IRS distribution table.

This IRS distribution table calculates your life expectancy based on your age. The table gives you a number that corresponds to the number of years the IRS expects you to live.

For instance, let's say a retiree was born on February 4, 1948, and will turn 70 in the first half of 2018. This retiree has a single IRA, with a balance of $250,000 at the end of 2017 (the calendar year before the year in which she turns 70½). To calculate her RMD, she'd look up her age (70) on the IRS distribution table to find the distribution period, which in this case is 27.4. She would then divide her IRA balance by the distribution period for her 2018 RMD:

IRA balance / Distribution Period = RMD

$250,000 / 27.4 = $9,214

To keep on the right side of Uncle Sam, she will need to withdraw a minimum of $9,214 from her $250,000 IRA in 2018. But remember, the operative word is "minimum." Account holders can always take more than their RMD if they choose to do so.

Why am I celebrating my 70½ birthday?

While 70½ may seem like an arbitrary number, there is a lot of thought put into this milestone age. The IRS makes a distinction between people born in the first half of the year, and those born in the second half. If your birthday falls between July 1 and Dec. 31, you don't officially have to take an RMD until the year you turn 71.

This means that those with birthdays in the first half of the year take their first RMD the year they turn 70, and those with the later birthday take their first RMD the year they turn 71 — which averages out to 70½. (See also: 6 Age Milestones That Impact Your Retirement)

Required beginning dates

To offer retirees a little more time to get their ducks in a row, the IRS does not require account holders to take their first RMD until April 1 of the year following the one in which you reach age 70½. That April 1 deadline is known as the required beginning date. The year in which that date falls depends on whether you have a birthday in the first or second half of the year.

So, our Aquarian born Feb. 4, 1948 will turn 70½ on Aug. 4, 2018. But remember, those born in the first half of the year calculate their RMD based on the year before they turn 70. So while she can wait to take her first RMD until April 1, 2019, at that point she'll calculate that RMD based on her age of 70 (which was her age as of Dec. 31, 2017), as well as her account balance as of Dec. 31, 2017.

The first year following the year in which you reach 70½ you will usually have two required distribution dates. Besides the April 1 date we just discussed, you'll also have to take another withdrawal by Dec. 31 of that same year. For our Aquarian, that means she will have to take a second RMD by Dec. 31, 2019. This RMD will be calculated based on her 2019 age of 71 and her account balance as of Dec. 31, 2018. This distribution catches her up on her requirements, and during all subsequent years, she is only required to take one RMD.

The required beginning date is similar for anyone with later birthdays. Let's say you're a Virgo with an Aug. 31, 1948 birthday. You'll turn 70½ on Feb. 28, 2019, which means you won't have to take your first RMD until April 1, 2020, and you'll calculate the amount based on your age of 71 (which is your age as of Dec. 31, 2018) as well as your account balance as of Dec. 31, 2018 — the year before you turned 70½. In addition to the April 1, 2020 distribution you will also have to take your 2020 RMD by Dec. 31, 2020, which you will calculate based on your age then of 72, and your account balance on Dec. 31, 2019.

Figuring out your required beginning date

If your birthday falls between Jan. 1 and June 30

If your birthday falls between July 1 and Dec. 31

Your required beginning date is April 1 of the calendar year you turn 71.

Your required beginning date is April 1 of the calendar year you turn 72.

You will use the age of 70 to calculate your first RMD amount.

You will use the age of 71 to calculate your first RMD amount.

Your second RMD is due by Dec. 31 of the calendar year you turn 71.

Your second RMD is due by Dec. 31 of the calendar year you turn 72.

How your RMDs are taxed

Since the entire exercise of taking RMDs is about making sure you pay the income taxes you owe, it's important to understand how your distributions will be taxed.

Your RMDs will be taxed as regular income at your applicable federal tax rate for the tax year for which you are making the withdrawal. This, in fact, may be the easiest-to-understand aspect of RMDs.

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