Required Minimum Distributions (RMDs) tend to be confusing for investors. Investors often have a lot of questions about RMDs and their implications. Let’s address the most common questions.
What is a Required Minimum Distribution (RMD) and how is it calculated?
A Required Minimum Distribution (RMD) is the amount of money that must be withdrawn from an employer-sponsored retirement plan, traditional IRA, SEP IRA or SIMPLE IRA. RMDs are calculated by dividing the retirement accounts prior year-end fair market value by the IRS life expectancy factor. The life expectancy factor is published in life expectancy tables each year.
When am I required to start taking RMDs?
If you were born before July 1, 1949, you are required to take your Required Minimum Distribution when you turn 70½. For those born after that date, the SECURE Act changed the required age to 72. To complicate matters, the CARES Act waived your distribution in 2020 and issued new RMD life expectancy tables starting in 2022, not only for your RMD, but also new rules and life expectancy tables for inherited IRAs. The good news about the changes is that it does give you a modest tax savings by reducing the required amount.
Can I take the RMD as a lump sum? Or should I take distributions throughout the year?
That’s completely up to you! Some choose to take it as a lump sum, others take it monthly or quarterly. Regardless of what you choose, it is important to ensure your RMD is set up properly and taken by the end of each year, so as not to trigger a potential 50% penalty.
Are RMDs taxed?
Since RMDs come from IRAs, which are pre-tax dollars, you are taxed on the distribution just as you would be taxed on any other distribution from your IRA.
I have a few different types of IRAs. Do the RMD rules differ?
There are a few nuances that you should be aware of. If you have a traditional IRA, SEP IRA, or Simple IRA, you have until April 1st of the following year to take your first distribution. However, if you wait until April 1st, you will be required to take two distributions: one for your initial year and one for the current year. Depending on your tax situation, having two distributions in one year could cause you to move into a higher tax bracket and possibly owe additional taxes on Social Security and pay higher Medicare premiums. Be sure to review the situation with your tax preparer to determine the best course of action. If you turned 72 in 2021, your initial required beginning date is April 1, 2022. If you defer to this date, your 2021 RMD will be calculated with the old tables and the 2022 RMD that is due by December 31, 2022, will be calculated with the new tables. This can absolutely be confusing, so be sure to take your time to calculate the distribution properly.
If you have a 401(k) or similar workplace plan and are still working at that company, and do not own more than 5% of the company, you can defer your distribution from this account until the year that you retire. Thankfully, Roth IRAs do not have a required distribution.
I recently inherited a retirement account. Do the rules differ?
If you inherited an IRA, SEP, Roth, etc. prior to 2020, you could generally “stretch” your required distributions based on the life expectancy table for non-spouse beneficiaries. The SECURE Act replaced the life expectancy tables with a 10-year payout requirement. If you are considered an eligible designated beneficiary (EDB) under the new rules, then you may be able to use the newly updated life expectancy tables and “stretch” your required payouts. An EDB includes spouses, minor children of the decedent, beneficiaries not more than 10 years younger than the decedent, or disabled individuals. Rules differ for non-spouse beneficiaries.
As you can see, there are plenty of subtleties and exceptions, so it is worth connecting with an advisor to talk through your specific RMD situation.