Required minimum distributions (RMDs) are distributions mandated by the IRS from certain tax-advantaged retirement accounts, commencing at a specified age. RMDs are generally taxable and this is the government’s way to recoup some of the tax advantages account holders earned while saving for their retirement. RMDs represent a minimum amount that must be distributed, account holders are free to withdraw a larger amount from their account during the year.
What is an RMD?
RMDs are mandatory annual withdrawals that must be taken from traditional IRAs, employer retirement accounts such as 401(k)s, SEP-IRAs and SIMPLE IRA accounts. RMDs commence at age 72 based on the SECURE Act that went into effect on January 1, 2020. Prior to that, RMDs commenced at age 70 ½. Those who were taking RMDs prior to January 1, 2020 must continue on that schedule.
RMDs from a traditional IRA, 401(k) or other type of retirement account are generally fully taxable at the account holder’s ordinary income tax rate, assuming that all contributions to the accounts were made on a pre-tax basis over the years.
In the case of a traditional retirement account where there have been after-tax contributions, those amounts are not taxed. The total ratio of after-tax contributions to pre-tax contributions and earnings on the money in the account can be used to exclude a portion of the RMD amount from taxes. For example:
- Total traditional IRA balance of $150,000.
- Total after-tax contributions $10,000.
- Total RMD $5,475.
- A portion of the RMD not taxable is $365 based on the ratio of the value of total after-tax contributions relative to the total year-end value of the account(s) used to determine the total RMD.
Roth IRAs are not subject to RMDs. Roth 401(k) accounts are subject to RMDs, but the RMDs are not taxed. Rolling a Roth 401(k) account over to a Roth IRA account can allow the account holder to avoid RMDs on this money.
How is the Required Minimum Distribution Determined?
There are a number of factors that go into determining the amount of your RMD or RMDs for a given year.
The amount subject to the RMD is based on the value of the account as of December 31 of the prior year. For example, RMDs to be taken in 2021 are based on account values as of December 31, 2020. The RMD must be taken by December 31, 2021 in this case.
There is an exception for those taking their first RMD upon reaching age 72. Taking the first RMD can be deferred until April 1 of the following calendar year, April 1, 2022 in the case of an RMD for 2021. The issue to consider is that this could result in having to take two RMDs in the same calendar year, resulting in a higher tax bill for that year.
How do I calculate my required minimum distribution?
As a practical matter, all major brokers and investment custodians calculate your RMD for you as they are required to report this amount to the IRS. This arose out of the IRS’ efforts to beef-up enforcement of the penalty for not taking some or all of your RMD. The penalty is 50% of the RMD not taken by the deadline, plus taxes are still due on this amount.
Typically the account custodian will report the amount of your RMD for the current year to you in January of the year they must be taken.
RMDs are calculated by taking the year-end balance of the account and dividing this amount by the factor on the appropriate IRS table. For most taxpayers, the IRS uniform lifetime table is the appropriate table to use. This table applies to:
- Unmarried account owners.
- Married account owners whose spouses are not more than 10 years younger.
- Married account owners whose spouses are not the sole beneficiaries of the account.
Age115 and over
There are two other tables in IRS Publication 590 that apply to account owners with circumstances other than these.
RMDs from traditional IRAs are based on the total value of all traditional IRAs for those with multiple accounts. The RMD can be taken all from one account, from each account or any combination of accounts as long as the total RMD amount from the combined accounts is taken.
RMD calculation example
Sarah is 73 years old and her IRA balance was $359,711 at the end of 2020. Her RMD for 2021 would be calculated as follows:
- IRS factor for her age: 24.7
- Ending 2020 balance of $359,711 divided by 24.7 equals $14,563
In this case Sarah must take the entire $14,563 as a distribution from her IRA by December 31, 2021.
If Sarah also had a 401(k) account from an old employer with a year-end balance of $100,000, her 2021 RMD for this account would be:
Ending balance of $100,000 divided by 24.7 equals $4,049. Sarah would need to take this RMD in addition to the amount tied to her traditional IRA account.
RMDs in 2021
Due to the COVID-19 pandemic, the RMD requirement was waived in 2020. RMDs for 2021 must, however, be taken in 2021 based on the normal calculation for your age.
There is no catch-up or anything along those lines due to the 2020 waiver. For those who didn’t take their 2020 RMD, their 2021 RMD could potentially reflect a larger end of year account balance in their retirement account which would be divided by the IRS factor for their age.
Inherited IRAs occur when a beneficiary inherits an IRA from the account owner. The rules surrounding inherited IRAs and RMDs can be complex. Here is an overview.
Spouses inheriting an IRA from their deceased spouse can treat the IRA as their own provided they are the sole beneficiary of the account. This includes taking RMDs, however if the deceased spouse had already commenced taking RMDs the surviving spouse has the option to continue taking them as well. Surviving spousal beneficiaries have a number of options in handling inherited IRAs and RMDs and should consider consulting with a financial advisor to determine the best option for their situation.
For IRAs inherited prior to January 1, 2020, non-spousal beneficiaries had the option to stretch this IRA by taking RMDs based on their own life expectancy among other options. For beneficiaries who were younger than the original account owner this allowed the beneficiary to stretch the IRA out for years by taking RMDs based on the IRS factor for their age, which would result in a relatively low RMD number. IRAs inherited prior to January 1, 2020 can continue on this path for RMDs.
The SECURE Act which went into effect on January 1, 2020 changed the RMD landscape for non-spousal beneficiaries. For most non-spousal beneficiaries, the option to stretch out the inherited IRA by taking RMDs over their own life expectancy is gone. Rather they must withdraw all money from the inherited IRA within 10 years of inheriting it.
A special class of non-spousal beneficiaries called eligible designated beneficiaries can still stretch their inherited IRA via the RMD method. Beneficiaries who fall under this grouping include:
- Beneficiaries who are at least 10 years younger than the original account holder.
- A beneficiary who is chronically ill or disabled as defined by the IRS.
- The child of the original account holder who has not reached the age of majority in their state. Once they do reach that age, they become subject to the new 10-year rule.
- Certain trusts.
Is it better to take the RMD monthly or annually?
RMDs can be taken at any point during the year as long as the full amount is withdrawn from the account(s) by December 31 of the appropriate year. Whether you take the distributions annually, monthly or randomly throughout the year is up to you. The best answer here is to do what’s best for your situation.
Most custodians and brokers will allow you to set up automatic distributions at intervals of your choosing. You can generally have the money transferred to a taxable account within the same organization, to an outside account or have a check mailed to you. It’s a good idea to have taxes withheld from the RMD to help ensure that you don’t owe an excessive amount when you file your taxes.
Qualified charitable distributions (QCDs)
QCDs allow traditional IRA account holders to use up to $100,000 in distributions each year to make contributions to qualified charitable organizations. Account holders must be at least age 70 ½ to use this option. QCDs can exceed the amount of your RMD for the year as well.
QCDs are a great option for those who are charitably inclined. QCDs are not subject to income taxes, but there are no tax deductions for QCDs. For those who do not need some or all of the money from the RMD, QCDs can be a very tax-efficient method for making charitable contributions.
QCDs are just one strategy to reduce the tax impact of RMDs. There are a number of additional strategies to reduce the tax impact and the amount of future RMDs, we will cover these in a separate article on the site.
Can I reinvest my RMD?
RMDs cannot be reinvested back into the retirement account from which they were distributed. The RMD money, can however, be invested in a taxable brokerage account or other types of taxable investments. The money is yours to use as you see fit.
If you do have earned income and are eligible to do so, the money could be reinvested in a Roth IRA in some cases.
Do Roth IRAs have required minimum distributions?
One of the major advantages of a Roth IRA is that they are not subject to required minimum distributions. This allows the money in the Roth IRA to grow without being depleted by annual RMDs. Note that balances in a Roth 401(k) are subject to RMDs, but these are generally not taxable. In order to vaid the RMD on a Roth 401(k), the account holder can roll this amount over to a Roth IRA at an outside custodian.
Are there required minimum distributions for annuities?
Annuities by themselves are not subject to RMDs. This is true of non-qualified annuities that are held outside of a retirement plan. Qualified annuities, which are annuities held inside of an IRA or other type of retirement plan, are subject to RMDs just like any type of asset held inside of a retirement account such as an IRA.
Do RMDs affect Social Security?
RMDs do not impact the amount of your Social Security benefit. This is determined based on your age and career earnings record with Social Security.
The income from your RMD can impact whether or not your Social Security benefit is subject to taxes. Social Security benefits are subject to taxes above certain levels of income. Another related impact of RMDs could be in pushing you to a higher premium level for Medicare Part B premiums which are also based on income.
RMDs are a key part of managing your retirement accounts. It's important to understand the amount of your RMD and to be sure to take the RMD by the deadline. Some of the rules surrounding RMDs can be complex and it can make sense to consult with a knowledgeable financial and tax advisor.