What Are RMDs, And Who Needs to Take Them?
by John Cooney on Dec 9, 2018
Tax deferred retirement plans help you efficiently prepare during your working years for financial security in retirement. By contributing to a tax deferred retirement plan, you are able to avoid paying taxes on the income you earn in the year that you earn it, theoretically allowing you to put more money away now, which then grows tax deferred, paying taxes only when you withdraw the money later. By deferring the taxes, and through thorough planning, you can withdraw this money during years when your tax liability is low, ensuring more of your money stays with you. That said, they are tax deferred plans, and you can only defer paying the taxes for so long. When it comes to plans such as 401Ks and IRAs, that so long is when your turn 70 ½ years old.
Required Minimum Distributions (RMDs); What Are They and Who Has to Take Them?
RMDs are the government’s way of ensuring that at some point, taxpayers are required to pay taxes on money that they earned and subsequently put in to a tax deferred plan, such as a 401K or an IRA. The IRS has determined that anyone who has invested in an IRA, which includes traditional IRAs, SEP IRAs, and SIMPLE IRAs, must begin taking RMDs by April 1st of the year following the year they turned 70 ½. Subsequent RMDs must be taken by the 31st of December. For example, Bob turned 70 ½ on May 1st, 2018, and has a traditional IRA. His first required RMD must be taken by April 1st, 2019. His second RMD will be required to be taken by December 31st, 2019. The first RMD covers 2018, the second RMD covers 2019.
For defined contribution plans, such as 401Ks or 403Bs, the rules are slightly different. You are still required to take your first RMD by April 1st in the year following the year you turn 70 ½, UNLESS you are still working and your plan allows it, then you can put off RMDs for that employer’s defined contribution plan until the year after you retire. This exception does not apply if you own 5% or more of the company that you are working for. It is also important to note, while Roth IRAs do not require RMDs, Roth 401K balances do, so do not forget to include Roth 401ks in your RMD discussion and calculation.
How Do I Determine How Much I Need To Withdraw?
To determine how much the IRS requires you to withdraw, you need two things; the value of your account on 31 December and the Uniform Lifetime Table.
Calculating the RMD for IRA accounts:
Each IRA that a taxpayer owns has to be separately accounted for RMDs, however, the taxpayer can choose to take the RMD withdrawal for both amounts out of one IRA. Let’s look at an example. Bob, 72 years old, has two IRAs, IRA one had a balance of $62,000 on 31 December 2017, IRA two had a balance of $38,000 on 31 December 2017. As a 72-year-old, Bob’s distribution value from the Uniform Lifetime Table is 25.6.
$62,000 divided by 25.6 = $2,422
$38,000 divided by 25.6 = $1,485
Bob’s total RMD for his IRAs, due by 31 December 2018 is $3,907. He can take all $3,907 out of one of his IRAs, or take a portion out of each, as long as he takes out a total of $3,907.
Calculating RMDs for Defined Contribution Plans (401Ks, 403Bs, etc.)
Generally, RMDs for a defined contribution plan are calculated separately for each tax-deferred account and unlike the RMDs for IRAs, with defined contribution plans, each plan must be debited separately for the RMD. The calculation requires the same information; 31 December balance and the Uniform Lifetime Table. Again, the biggest difference is that each account must satisfy the RMD. Also, typically, the plan administrator or sponsor should calculate this RMD amount for you, with IRAs, you are often on your own.
What If I Want to Take Out More Than the RMD?
No problem! You are not required to only take out the RMD, you just have to take out at least the amount of the RMD.
Do I Have to Take it Out in One Distribution?
No, you can withdraw it in multiple distributions over the course of the year, or in one withdrawal, you just have to make sure you have taken out at least the full amount by 31 December.
What Happens If I Don’t Take My RMD?
If your distributions are less than your RMD, the IRS levies a tax equal to 50% of the un-distributed amount. For example, if your RMD was for $1000 and you only took out $500, the IRS will charge you an additional $250 (50% of the $500 under distribution).
Need Help With Your RMD Plan?
Tax deferred accounts should be part of your overall retirement savings plan, just remember, the taxes are deferred, not eliminated! Make sure you know what accounts you own, whether RMDs are required, and how much those RMDs need to be.