What is a Required Minimum Distribution (RMD)?
A Required Minimum Distribution (RMD) is the minimum amount that an IRA owner must withdraw yearly, starting with the year that he or she reaches age 72. Traditional IRAs, SEP IRAs, SIMPLE IRAs and Individual 401(k) plans are subject to this rule. Failure to take any portion of the minimum amount will incur a 50% penalty on the portion failed to be distributed. Keep in mind, the amount that must be withdrawn changes each year. The amount is based on a formula using the age of the individual for the year and the prior year-end account balance. Each retirement plan RMD must be calculated separately, however, if the account is an IRA, the amount can be distributed from other IRAs held by the account holder.
The typical deadline for taking RMDs is December 31 of each year. If it’s the first RMD, the distribution deadline can be extended until April 1 of the following year after they turn 72. If the first RMD is delayed, there will be two RMDs in that following year. It is important to know that taking more than the RMD will not reduce the amount of the following year’s RMD.
- If your spouse is the only primary beneficiary to your account and is more than ten years younger than you, you must use the IRS Joint Life and Last Survivor Expectancy Table (Table II in IRS Publication 590). Using this table will yield the smallest amount.
- You're not required to take RMDs from a Roth IRA. The RMD rules, however, will apply to beneficiaries that inherit your Roth IRA when you die.
How to Calculate your Required Minimum Distribution
Your RMD is generally determined by dividing the adjusted market value of your IRAs as of December 31 of the preceding year by a life expectancy number that corresponds with your age under the Uniform Lifetime Table [Table III in IRS Publication 590, Individual Retirement Arrangements (IRAs)]. The age used on the table is the age you would attain as of your birthday during the year. If your spouse is your sole beneficiary, and is more than 10 years younger than you, you have the option to use the Joint Life and Last Survivor Expectancy Table (Table II in IRS Publication 590) which will reduce the amount required. For Individual 401(k) plans, the Employer/Plan Sponsor is responsible for calculating and distributing the RMD from the plan. Failure to distribute the RMD for plan participants will jeopardize the plan’s qualified status which has tax consequences including plan disqualification.
Update from the SECURE Act of 2019: certain beneficiaries will no longer have the life expectancy option regarding inherited retirement plan accounts. Instead they will be required to distribute the inherited account in its entirety 10 years from the date of death of the IRA holder. Individuals who are exempt from this limitation are the IRA holder’s spouse, a disabled individual, a beneficiary less than 10 years younger, a chronically ill beneficiary, and a beneficiary who has not reached age of majority (minor). The minor beneficiary will revert to the 10-year option once they reach adulthood.
You can calculate your RMD with a few easy steps:
1. First, you must find your age that you would attain as of your birthday for the year. This age will have a corresponding distribution period or 'Life Expectancy Factor' on the table.
2. Your IRA balance as of December 31 of the previous year is then divided by your Life Expectancy Factor to calculate your RMD.
What penalties can occur if a RMD is not taken?
IRA holders will be subject to a 50% penalty for any amount failed to be distributed.
Example: As an example, if your RMD is $500.00 and you only distributed $400.00, you will have a penalty of $50.00.
Certain investments that are hard to liquidate may be an issue when it comes to taking a RMD. Although taking an in-kind distribution of a property may be an option to satisfy the RMD, it may be difficult and sometimes costly due to the costs involved in valuing the investment as part of the distribution process.
Option 1: Paying the 50% penalty, which many people don't think of. By paying the 50% penalty using the IRS Form 5329 and completing Section 9, the RMD does not have to be distributed for the year.
Keep in mind that distributions are subject to tax. The tax owed may not quite be 50% but will still cost the individual taking into account the federal and state tax on the distribution. Not taking the distribution also keeps the investment intact.
Option 2: Convert assets from their Traditional, SEP and SIMPLE IRAs to a Roth IRA. Roth IRAs are not subject to RMDs for the Roth IRA holder. Any RMD must be satisfied before converting any remaining assets.