If you’re over the age of 70½ and have an IRA account, you need to consider how required minimum distributions (RMDs) fit into your retirement withdrawal strategy. This obligation is set forth by the IRS, so the sooner you determine your plan, the better off you’ll be once tax season rolls around.
The RMD represents the minimum amount of money the IRS requires you to withdraw from all your IRAs and retirement plans, except for the Roth IRA. If you don’t withdraw the minimum amount, you will be forced to pay a 50% federal penalty tax on the difference between the amount you withdrew and the amount you were required to take.
Remember, IRA stands for Individual Retirement Account. As such, the IRS rules apply to you, the individual. This includes your age, not the age of anyone else.
You’re probably thinking, why am I required to start taking the RMD at age 70½? Well, very simply, the government wants to prevent you from deferring the tax within your IRA forever. Once you reach this age, you are obligated to take the RMD each year until your death.
In other words, the RMD is not a one-time thing, but applies for the rest of your life once you reach age 70½. This fact is often lost on people who are of the age where RMD becomes a condition, leading to stiff penalties during tax season.
Now you might be asking, how do I determine my minimum distribution? This part is actually very simple. Your RMD is the market value of your IRA on January 1 of each year, divided by your life expectancy for the age you will reach that year.
To calculate the number, you must determine the cumulative value of all your retirement savings and divide it by your life expectancy that year. Your life expectancy factor is found on the Uniform Lifetime Table provided by the IRS.
The life expectancy for someone age 70 is 27.4. This applies to both men and women. If the cumulative market value of your IRAs and other retirement savings is $100,000, then your RMD for that year is $3,649.64. That number is obtained simply by dividing $100,000 by 27.4.
On the surface, compliance with the RMD seems straight forward, but of course, very few tax obligations are simple. The RMD contains some nuisances that can easily trip you up.
- The first nuisance to bear in mind is that the cumulative market value of your retirement savings change. This means the RMD must be recalculated each year as life expectancy decreases. You’ll want to make sure that you calculate the RMD correctly because if you take out less than the required amount, you are subject to the 50% penalty tax. That’s a stiff price to pay for money that’s already yours!
- Another consideration is that your life expectancy never goes to zero on the Uniform Lifetime Table, nor does it decrease by one for every year of your life. Rather, it decreases by 0.9 initially, then 0.5 as you age, then 0.4. You eventually reach a life expectancy of 1.9 at age 115 and after.
- There’s also a special rule for inherited IRAs. If you inherit an IRA from your parent before the age of 70½, you must take the RMD each year beginning when you inherited it. If your parent passed away when you were 50, that’s the year the RMD on the inherited IRA applies to you.
- The RMD does get more complex after all the above is considered. For example, if you have multiple IRAs, 401(k)s and other retirement savings, you may take the RMD from any one of the plans. This means you do not have to prorate the RMD across all your plans. Still-working exceptions for RMDs also apply, but only to the 401(k) plan.
As you’ve no doubt noticed, our tax code is the furthest thing from simple. This is especially true as it applies to withdrawing from your retirement account.
Suffice it to say, that if you have an IRA and are over the age of 70½, I would recommend seeking help from a professional who is familiar with far more than Required Minimum Distributions Class 101.
 Vanguard. Estimate your required minimum distributions in retirement.