- Required minimum distributions (RMDs) are part of a complex tax code that impacts retirees and most retirement accounts.
- RMDs require that you take a certain amount of money out of your retirement accounts once you reach age 72.
- You should make sure you understand the rules surrounding RMDs to avoid a steep tax bill.
If you’re nearing retirement or in retirement, you’re no doubt wondering how much money you can start withdrawing from your retirement accounts and when. And you’re right if you suspect that it may not always make sense to take distributions from all of your retirement accounts every year.
Regardless of your strategy, the IRS requires you to withdraw a minimum amount from most tax-advantaged retirement accounts once you reach a certain age.
“Required minimum distributions are essentially Uncle Sam’s way of saying ‘It’s time to pay the piper’ for allowing you to defer taxes all those years,” says Frank Murillo, partner and managing director at Snowden Lane Partners, a wealth advisory firm. “It prevents tax-deferred and tax-free accounts from growing in perpetuity, especially across generations as they become inherited.”
If you’re unsure about how required minimum distributions (RMDs) work, here’s what you need to know.
Inside this article
What are RMDs?
RMDs are the amount of money that you must withdraw from your retirement accounts once you reach a certain age. If you don’t, you could face a steep tax bill on the amount you should have withdrawn. Here’s how they work:
The age at which you need to start taking RMDs is 72. According to the IRS, you need to start taking RMDs by April 1 of the year after you reach age 72. So, if you turn 72 on July 1, 2022, you’d need to take your first RMD by April 1, 2023, as well as in subsequent years.
The age rule is waived on most retirement plans if you haven’t retired by age 72, deferring to the year in which you retire. The only exceptions are if you have a traditional IRA or if you own 5% or more of the business that sponsors your retirement plan.
If you’ve inherited a retirement account, rules can vary depending on your relationship to the original account owner.
Which accounts are included in RMD rules?
RMD rules apply to all employer-sponsored retirement accounts and most individual ones, including:
401(k) plans, including solo 401(k)s
Roth 401(k) plans
Traditional individual retirement accounts (IRAs)
Simplified Employee Pension (SEP) IRAs
Savings Incentive Match Plan for Employees (SIMPLE) IRAs
RMD rules do not apply to Roth IRAs, at least not while the account’s owner is still alive. If it’s inherited, most beneficiaries must take RMDs.
Retirement accounts provide tax savings to those who contribute to them, and most are tax-deferred, which means you don’t have to pay taxes on your gains—and also often your contributions—until you take withdrawals in retirement.
How much do you need to withdraw?
RMD calculations can be a bit tricky because they’re based not only on your retirement plan balance but also on your life expectancy.
More specifically, you’ll take the balance of your retirement account from Dec. 31 of the previous year and divide it by a distribution factor published by the IRS, which is based on life expectancy. The IRS has a few different tables of distribution factors you can use, depending on whether you are:
A beneficiary of retirement accounts
A plan owner whose spouse is more than 10 years younger and are the sole beneficiary of your accounts
An unmarried plan owner, married owner whose spouse isn’t more than 10 years younger or married owner whose spouse isn’t the sole beneficiary of your accounts
For example, let’s say you’re unmarried, turned 72 last year, and at the end of the year, your retirement plan balance was $500,000. The distribution factor for your age is 27.4, according to the 2022 IRS draft. So you divide $500,000 by 27.4 to get an RMD for the current year of $18,248.
Of course, you can take more than that if you’d like, but you need to withdraw at least that amount to avoid a penalty. Each year, your RMD will vary based on the distribution factor for your age.
If you’re concerned about not getting the number right, “many investment firms run these calculations as a matter of procedure,” says Doug Kinsey, a partner at Artifex Financial Group, a fee-only wealth management firm.
You can also work with a Certified Public Accountant (CPA) or a qualified fee-only financial planner to get the help you need, which can involve not just RMDs, but putting the right accounts in place and planning ahead to maximize your income in retirement.
What happens if you don’t take your RMD?
If you don’t withdraw any money in a year in which RMD rules apply, or you don’t withdraw the amount required, you may be assessed a 50% tax on the amount that wasn’t distributed as required.
Referring back to the example above, with an RMD of $18,248, that’s a tax of $9,124 if you don’t take out anything that year. If you take out $10,000, you’d owe $4,124.
If you’re looking to avoid RMDs or simply reduce how much you need to take, there are a few options:
Convert to a Roth IRA
By converting some or all of your employer-sponsored retirement plan or traditional IRA balance to a Roth IRA, you’re moving money into an account that’s not impacted by RMD rules (unless you’ve inherited a Roth IRA).
“Roth conversions are essentially planned distributions of a retirement account prior to RMD age that effectively reduce the taxable amounts paid throughout a consumer’s life span,” says Murillo.
That said, when you convert funds from a tax-deferred retirement account to a Roth IRA, which is a tax-free account, you may owe taxes on any amount of the balance that hasn’t previously been taxed, including both contributions and gains.
Donate to a Charity
If you’re 70½ or older, you can donate up to $100,000 from your retirement plan directly to charity.
“A qualified charitable distribution has the dual benefit of counting towards your RMD and not counting towards your taxable income if the payment is made directly from the retirement account to a qualified charitable organization,” says Murillo.
This approach is best for high-net-worth individuals who have enough retirement income from other sources and are looking for ways to reduce their taxable income.
Save in Taxable Accounts
RMDs are only applied to select retirement accounts. So, if you decide to save money for retirement in a taxable brokerage account, you don’t need to worry about RMDs.
However, these accounts don’t provide the same tax benefits as qualified retirement plans, so you may ultimately leave more money on the table with this approach.