Understanding Required Minimum Distributions
Required minimum distribution, RMD for short, is the smallest amount you’re required to withdraw each year from your retirement accounts when you reach age 70½. You’ve had that money stashed away in tax-deferred accounts for years, or even decades. So the federal government passed laws that you must take some of that money out so they can tax it.
The IRS applies RMDs to the following retirement accounts:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans
- 403(b) plans
- 457(b) plans
- Profit sharing plans
- Other defined contribution plans
You can, of course, withdraw more than the minimum required amount. However, taking out more in any given year could result in being bumped into a higher tax bracket. You spent your entire working life keeping that money safe from taxes, no need to give the IRS more than is necessary!
The IRS requires you start taking RMDs in the year you reach age 70½. Why that age? There is no clear answer. Most likely it was an arbitrary number agreed upon when the law was passed. The RMD can be delayed to as late as April 1 of the following year, depending on when you turn 70½. That will affect how much you have to take out since one factor of your RMD is how much is in your account at the end of the previous year.
The RMD is calculated by dividing your balance by the distribution period. The distribution period is how long the government thinks you’re going to need to make your retirement last. Essentially how many years the government thinks you have left to live. So at 70, your distribution period is 27.4 years. At 80 years old, it is 18.7. Two things happen as you get older: the government gives you better odds of living longer, and the percentage for your RMD increases.
If you have an IRA worth $100,000 when you go to take out your first RMD, you would divide $100,000 by 27.4, meaning your RMD for that first year is $3,649.64. With that same account, if you only took out the RMD every year, you would be withdrawing $3,435.80 when you are 80. Charts and calculators can be found all over the Internet with a quick Google search.
You can delay taking required minimum distributions from your current employer's 401(k) while you are still working. The only exception is if you own five percent or more of the company. With IRAs of any kind, you must start taking the RMD at 70½ even if you are still working.
There are few loopholes to use to help avoid paying taxes on your RMD. The only one is the qualified disaster tax relief. This is money you were allowed to stash away, untaxed, for years or even decades. And hopefully, your retirement years are not spent recovering from a disaster.
You can reinvest your RMD. The whole point of retirement saving is to make the money that you workedso many years for work for you. How you go about doing that is a personal preference. Talk with a financial advisor at your local credit union, they are there to help you.
If you want to avoid RMDs all together, you can set up a Roth IRA. This option is probably suited for younger people just starting their retirement savings. Again, this is something that would be best to discuss with a financial advisor at your credit union.
Overall, the task of saving for retirement is up to you. Company pensions are mostly a thing of the past. With life expectancy continuing to increase, you’re going to need larger savings than you might expect. Not to mention you will finally have time to use the money you diligently saved for years. Why waste it by having to pay more taxes than necessary or get hit by fines? Plan ahead, not just for your retirement, but for the costs and taxes that might be associated with it.