When you reach age 70Â˝, the government requires you to begin withdrawing money from your retirement savings accounts each year. This sum, known as a required minimum distribution (RMD), allows the IRS to begin collecting income tax on the dollars youâ€™ve stashed away in tax-deferred accounts such as a 401(k) or traditional individual retirement account (IRA).
Regulations governing most retirement accounts state that you cannot leave funds in the account indefinitely. Even if you donâ€™t need the money, the government requires you to begin reducing the overall balance in most accounts by a set sum each year â€” the required minimum distribution â€” typically following your 70Â˝ birthday.
The precise amount of each personâ€™s required minimum distribution is determined by the IRS based on life expectancy and total savings. The RMD rule only applies to tax-deferred accounts or accounts that allow people to reduce their taxable gross income each year by the amount they set aside in the plan.
Because tax-deferred accounts provide upfront tax savings, the IRS waits to collect taxes on contributions to the accounts and any subsequent investment gains until the money is withdrawn. Hereâ€™s a full list of retirement accounts subject to the RMD rule:
The rule does not apply to Roth IRAs or Roth 401(k)s, as youâ€™ve already paid income tax on funds contributed to these accounts. Note, however, that once the original account owner dies, Roth IRAs are subject to RMDs.
Retirees will need to take distributions by April 1 of the year after they turn 70Â˝. Those with birthdays in the second half of the year benefit from this rule because it allows them to delay beginning taking RMDs for a little longer than those with earlier birthdays can.
For instance, if your 70th birthday is on July 1, 2019, you do not have an RMD for that year since you wonâ€™t turn 70Â˝ until Jan. 1, 2020, meaning you can wait until April 1, 2021 to take your first RMD. But being born just a day earlier, on June 30, would mean youâ€™d have to take your first RMD by April 1, 2020 (as youâ€™d reach 70Â˝ on Dec. 30, 2019).
If you are still working at age 70Â˝ and have a traditional 401(k) or 403(b) account with your current employer, you may not have to take an RMD from that account unless you own 5% or more of the company. Review your planâ€™s exact terms to see if it allows you to wait until you actually retire to begin taking RMDs or if it follows the same 70Â˝ rule regardless of retirement status.
Employment, however, wonâ€™t help you delay taking RMDs from any individual retirement accounts outside of your employer retirement account, such as a traditional IRA.
You do not have to take your RMD as one lump-sum payment. The IRS allows you to take out the funds in chunks throughout the year too. As long as the total meets the RMD for the year, youâ€™re in the clear.
Youâ€™re also not limited to taking only the RMD amount from your account each year â€” you can withdraw more than that threshold, if you want.
Just like filing your taxes, it falls on your shoulders to remember to take the RMD once you reach 70Â˝. You can do the math yourself (weâ€™ll explain below) to figure out what your required minimum distribution will be, or you can ask for help from a tax professional or financial adviser.
To calculate your RMD, you need to know exactly how much youâ€™ve got saved up in each account as of Dec. 31 of the previous year. Next, use the table below from the IRS to find your â€śdistribution periodâ€ť score, which is based on your life expectancy.
To calculate the RMD, divide the retirement account balance by the distribution period that corresponds with your age. Repeat this step for each of your accounts to come up with the total amount you must withdrawal for the year. Remember, your account balance will change and the IRS can update its distribution period figures, so redoing this math each year is crucial to ensure you take out the correct sum.
Letâ€™s say you turned 70Â˝ in December 2019 and had a balance of $1 million in your retirement account on Dec. 31. You would then find the distribution period that corresponds to your age in Table III or the Uniform Lifetime Table.
According to the table, your distribution period number is 27.4. When you divide $1 million by 27.4, you get an RMD of $36,496.35. That is the minimum withdrawal you must make from that account by April 1, 2020.
However, if youâ€™re married and your spouse is 10 years or more younger than you and is the sole beneficiary of the retirement account, you will need to find your â€śdistribution periodâ€ť score on this alternate table by locating the spot where your age and your spouseâ€™s age intersects.
For instance, if you turned 70Â˝ this year and had that same $1 million balance in your retirement account on Dec. 31, but were married to a spouse whoâ€™d just celebrated their 59 birthday, your distribution period number wouldnâ€™t be 27.4, but rather 28.1 to accommodate the longer expected lifeline of your spouse.
And this would mean youâ€™d need to take an RMD of $35,587.19 from that account for the year, or about $909.16 less than you would if you were single or married to a spouse closer to your own age.
If you donâ€™t take your first RMD by April 1 of the year after you turn 70Â˝ or your subsequent annual RMDs by Dec. 31 each year, youâ€™ll be slapped with a 50% excise tax on the amount that was not distributed when you file taxes.
Thatâ€™s a steep fine when you consider that the top tax rate is 37%, which is why it is so important to accurately calculate your RMDs each year, as the tax applies whether you fail to take any money from the account or simply donâ€™t take enough.
For example, if your RMD was $10,000, but you only took out $5,000, you will be assessed that 50% tax on the $5,000 that you did not withdraw.
Remember, if you delay taking your first RMD until April of the year following your 70Â˝ birthday, youâ€™ll be required to take two withdrawals in the same year, one for your 70Â˝ year and one for your 71Â˝ year, which could raise your gross income and move you into a higher tax bracket. To avoid this, you can opt to make your first withdrawal by Dec. 31 of the year you turn 70Â˝, instead of waiting till the following April.
Alternatively, you could reduce your taxable income by making a qualified charitable distribution paid directly from the IRA to a qualified public charity, not a private foundation or donor-advised fund. The charitable distribution can satisfy all or part of the amount you are required to take from you IRA and wonâ€™t count as part of your income.
If you withdrawal the RMD first, then donate it, this trick wonâ€™t work as the money will count toward your gross income.
If you have more than one retirement account, things can get a little more complicated. You still need to take an RMD, but you donâ€™t have to take one out of each IRA account. Instead, you can total the RMD amounts for all your IRAs and withdraw the whole amount from a single IRA or a portion from two or more.
However, you canâ€™t do the same with most defined contribution plans, like 401(k)s. With these accounts, you must take an RMD from each plan separately. One exception to this rule, though, is 403(b) tax-sheltered annuity accounts. If you have multiple of these accounts, you can total the RMDs and withdrawal from a single account.
If you own several different kinds of retirement accounts with RMDs, itâ€™s probably a good idea to seek advice from a tax or financial adviser professional who can help you make the wisest decision for your finances.
While itâ€™s great to be left the generous gift of a retirement account by a loved one, inheriting an IRA comes with its own set of tricky RMD rules that can vary greatly depending on your relationship with the original owner and how you chose to use the account.
If youâ€™re a spouse and sole beneficiary, you have the most flexibility in how to handle your new IRA. You can choose to treat the IRA as your own by designating yourself the account owner and making contributions or by rolling it over into an existing IRA account that you own. If you choose this option, you can follow the standard RMD rules â€” meaning you can wait until you turn 70Â˝ to begin taking money from the account.
Alternatively, you can roll the assets into whatâ€™s known as an inherited IRA. With this kind of account you can start taking distributions immediately and not face the typical 10% early-withdrawal penalty the IRS applies if youâ€™re under age 59Â˝.
To calculate the RMD youâ€™ll need to take with this kind of IRA, use the IRSâ€™s Single Life Expectancy Table, which has different distribution period figures than the standard table you would use if you were the original account owner. You can opt to use your own age for these calculations or your partnerâ€™s age as of their birthday in the year they died, reducing life expectancy by 1 each subsequent year.
But you may not need to take RMDs right away depending on how old your spouse was when they died. If they were older than 70Â˝ then youâ€™ll need to start withdrawing funds by Dec. 31 of the year following their death. But if they were younger, the IRS lets you leave the money in the account until your spouse would have reached 70Â˝.
Beneficiaries who are not a spouse are required to move the assets into an inherited IRA and begin taking RMDs regardless of the original ownerâ€™s age. If the person passed before age 70Â˝ you can opt to withdraw the full balance within the five years following the year of their death. Or you can prolong the payouts by taking RMDs annually based on your age, reducing beginning life expectancy by 1 for each subsequent year, using the Single Life Expectancy Table.
If the original owner was 70Â˝ or older, how you calculate your RMDs depends on whether you or the deceased was younger. The lowest age is what youâ€™ll base your life expectancy figure found in the Single Life Expectancy Table on, though you will need to reduce beginning life expectancy by 1 every subsequent year.
The original owner of a Roth IRA never has to take RMDs but that can change when the account passes to a beneficiary. A surviving spouse who inherits a Roth IRA can opt to treat the account as their own, meaning they wonâ€™t ever need to take an RMD, if they contribute to the account or roll into an existing Roth IRA.
Non-spouse beneficiaries, however, do have to take RMDs from an inherited Roth IRA, following the same rules as those who inherit traditional IRAs where the owner passed before reaching age 70Â˝.
That means these beneficiaries can either withdraw the entire balance from the Roth IRA within the five years following the year of the original ownerâ€™s death or begin taking RMDs based on your life expectancy, as outlined in the Single Life Expectancy Table, by the end of the year following the ownerâ€™s death.
Whether the retirement account was yours to begin with or youâ€™ve inherited it, calculating the correct RMD amount to withdraw from it every year can be tricky, but spending the extra time to make sure you understand the rules and check your math can pay off big time when youâ€™re not losing 50% of your savings to Uncle Sam in the form of a tax penalty.
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