There’s no shortage of acronyms in the world of personal finance. Between your HYAs, your NAVs, and your REITs, it can be hard to keep up with everything. But one of the most important acronyms, especially as you approach retirement, is RMD, or required minimum distribution.
An RMD is the amount of money that you must withdraw from your tax-free retirement account once you reach age 72. Knowing how these work is an important part of planning and saving for retirement.
They’re required by most retirement accounts
If you have a tax-deferred retirement account, then you may have to take RMDs starting at age 72. If your 70th birthday was before June 30, 2019, you may have been required to start taking RMDs at age 70 1/2. Retirement accounts that have this requirement include most 401(k) and 403(b) plans as well as traditional, SEP, and SIMPLE IRAs.
You don’t have to take RMDs from Roth IRA accounts.
Different accounts have different RMDs
If you have multiple IRAs (other than Roth IRAs), you will need to calculate multiple RMDs (one for each account). However, you have the option of paying for the total contribution amount for all your IRAs out of one IRA account as long as the total amount is satisfied.
For example, if you’re required to take $1,000 out of one IRA and $2,000 out of a different IRA, you could choose to just take $3,000 out of one to satisfy your RMD requirement.
For 403(b) accounts, the rules are the same as IRAs, but with 401(k) accounts, it’s a bit different. If you have multiple 401(k) accounts, each one will come with its own RMD amount and you must make a withdrawal from each account.
Consolidating accounts might be in your favor
Does the above make your head hurt? In some cases, you might find it easier to consolidate your retirement accounts so that you can more easily calculate your RMDs. If possible, try to do this well before the age of 72 so you’re not scrambling at the last minute or worse, hit with late penalties for not taking your RMDs on time.
They’re (usually) taken out starting at age 72
In most cases, RMDs kick in at age 72, and you must take your first RMD by April 1 of the year after you turn 72. Keep in mind that if you wait until the year after you turn 72 to take your first RMD, you will have to take two distributions that year.
For example, if you turn 72 in July 2022, you can wait until April 1, 2023, to take your RMD for 2022. You’ll also have to take an RMD for 2023 by Dec. 31, 2023.
However, if you’re still working for a company, the IRS doesn’t require you to take an RMD from that company’s retirement plan, provided that you don’t own more than 5% stock in your company. This applies only to the RMDs you have with that company, so you may need to start taking RMDs from other accounts after age 72.
They’re based on your life expectancy
Each of your RMDs will be calculated based on your account balance and your life expectancy. If you have multiple RMDs, you’ll have to calculate each one separately using an IRS life expectancy table. The tables vary depending on whether you have a spouse who’s the only beneficiary and the age of your spouse.
There’s a penalty if you’re late
The penalty for missing an RMD is steep. If an RMD isn’t taken on time, or less than the required amount is taken, the IRS will charge you 50% of the amount that wasn’t taken on time.
That means that if you were supposed to take a $1,000 RMD and don’t, you’ll owe the IRS $1,000 and a $500 penalty.
A Roth rollover might be helpful
If you move your retirement savings like traditional IRAs and 401(k)s into a Roth IRA (also known as a rollover), you won’t be required to take RMDs anymore. Instead, you can leave your money in your Roth account for as long as you’d like, and can even choose to never withdraw it and leave it as an inheritance.
You also won’t have to pay any taxes on withdrawals that you make from your Roth account as long as you are older than 59 1/2 and have had the account for at least five years.
Proceed with caution, though — when you roll over accounts to a Roth IRA, you pay taxes on the amount you move when you move it. That could lead to a hefty tax bill. On the plus side, you wouldn’t have to worry about RMDs.
QLACS can also help
A QLAC, or qualified longevity annuity contract, is designed to combat the issue of you outliving your retirement savings. You use funds from a retirement account to buy a QLAC, which provides you with a guaranteed stream of income for the rest of your life.
You can wait until age 85 to start taking income from the annuity. That’s also the age you’re required to start taking RMDs from your annuity.
You can donate RMDs
Feeling charitable? Good news — it’s actually possible to donate your RMDs as a qualified charitable distribution (QCD), and doing so is a great way to make a positive impact on some of the causes that are important to you. You can donate up to $100,000 as a QCD.
The act of retiring requires a lot of planning and record-keeping, but there are some things that you can do to ensure a smooth transition into life after work.
Even if you’re not yet of retirement age, it’s worth your while to find an accountant who can help you avoid taxes on RMDs. By knowing what to expect with RMDs, you’re saving yourself an unpleasant surprise. Do the research now — your future self will thank you.