Retirement funds are not meant to stay in your account forever. Once you reach 72 years old (or 73 if you are 72 after December 31, 2022), you must start withdrawing from your IRA, SIMPLE IRA, SEP IRA, or any other retirement plan account.
These mandatory retirement plan withdrawals are called Required Minimum Distributions or RMDs.
In this post we will explore the details of Required Minimum Distributions, including retirement plans subject to RMDs, how to calculate your minimum distribution, and the penalty for not making a required retirement plan distribution.
What are Required Minimum Distributions or RMDs?
Required Minimum Distributions, or RMDs, are retirement plan withdrawals that the IRS makes taxpayers take from tax-advantaged accounts when they are a specific age.
RMDs essentially guarantee individuals won’t skip paying taxes on retirement investments forever.
What Types of Retirement Plans are Subject to RMD Withdrawals?
RMD withdrawal rules apply to original account holders and beneficiaries of the following types of retirement plans:
Traditional IRAs
Individuals contribute pre-tax income, and the IRA grows tax-deferred until money is withdrawn during retirement.
SEP IRAs
Small businesses and self-employed individuals can contribute to a SEP IRA, and the contributions are tax-deductible. Similar to traditional IRAs, money is taxed when withdrawn during retirement.
SIMPLE IRAs
Another retirement plan for small businesses that both employees and employers make contributions to. SIMPLE IRAs are simpler and less costly than most 401(k)’s.
401(k) plans
Employer-sponsored retirement that employees contribute pre-tax income to. In some cases, employers will match an employee’s contributions. Like IRAs, taxes are paid when money’s withdrawn during retirement.
403(b) plans
403(b) plans are “401(k)” plans for qualified tax-exempt organizations, like non-profits and schools.
457(b) plans
Deferred state and local government retirement compensation plans, as well as for some specific non-profits.
Profit sharing plans
Employers make discretionary contributions to employee retirement accounts, and contribution amounts are based on company profits.
Other defined contribution plans
Any other employer-sponsored retirement plan, such as employee stock ownership plans.
Roth IRA beneficiaries
In the context of Roth IRA, individuals designated to receive the assets in the Roth IRA upon the account holder’s death are subject to RMD withdrawal rules.
When Do RMDs Start?
The following are the required start dates for the first RMD:
- IRAs such as SEPs and SIMPLE IRAs: Typically, you must take your first required minimum distribution on April 1 of the year following the calendar year you are age 72 (or 73 if you are 72 years old after December 31, 2022).
- Defined contribution plans such as 401(k), profit-sharing, 403(b): RMDs start on April 1 following the calendar year in which you are age 72 (or 73 if you are 72 years old after December 31, 2022) or retire.
How Do I Calculate My Required Minimum Distribution?
To calculate your RMD, divide the retirement account plan balance as of December 31 of the previous year by the distribution period based on your life expectancy factor.
You can use the IRS Life Expectancy Tables found in Appendix B of Publication 590-B (https://irs.gov/publications/p590b) to find the factor using the age you turn this year.
Note that there are three tables and the one you use depends on marital status, designated beneficiary, and difference in spouses ages if married. Table I is for Single Life Expectancy. Table II is for Joint Life and Last Survivor Expectancy. Table III is for Uniform Lifetime.
As an example, if you begin taking RMDs at age 75, have $1,000,000 in your IRA account, and use Uniform Lifetime Table III, your life expectancy factor is 24.6. Hence, your Required Minimum Distribution will be $1,000,000 ÷ 24.6 = $ 40,650.40.
How Much Is a Required Minimum Distribution Penalty?
The IRS will charge an RMD penalty if you fail to take the full Required Minimum Distribution amount by the mandated deadline. Historically, this penalty was 50% of the RMD amount not withdrawn.
However, recent legislation reduced RMD penalties to 25% of the required retirement distribution amount not withdrawn.
Additionally, new laws allow taxpayers who quickly correct a late RMD distribution to pay just 10% of the required distribution amount in penalties.
Keep in mind that the IRS requires you to take one RMD per year, and if you do not take your RMD, you must take two distributions in the following year.
Will the IRS Ever Waive an RMD Penalty?
If you have a plausible reason for missing the RMD deadline, you can request a waiver from the IRS using Form 5329. You can find this form at https://irs.gov/forms-pubs/about-form-5329.
Proactively planning for required minimum distributions (RMDs) and staying informed about potential changes in tax laws can help you enjoy a stress-free retirement.
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