If you have a retirement account and are at or nearing retirement age, you’ve probably heard of the term ‘Required Minimum Distribution’ (RMD) or will in the near future. It’s a term that could come into play for many retirees, and it’s helpful to know the basics of this requirement for certain retirement account holders.
What exactly is a Required Minimum Distribution, anyway? Over the life of your Traditional IRA, SEP, Simple, or qualified retirement plan account, you’ve had the benefit of tax deferral in some form- you haven’t had to pay taxes on your tax return each year on the growth inside your account, and in some cases your contributions were tax deductable as well! This feature is one of the main positives of IRA and 401k accounts. You get the benefit of growth and accumulation in the account without that growth being partially reduced by taxes every year. In return for granting account holders this feature, Congress enacted rules requiring account holders to being taking regular mandatory withdrawals after reaching a certain age in order to make up some of the tax revenue that was lost from these funds over the years that you’ve had the account.
The age that you need to begin these distributions is 70.5, and you have until April 1 of the year after you reach that age to take your first distribution. For example, say your birthday was June 1, 1941. Your 70.5 birthday would fall on December 1st of the current year, 2011. Since you reached age 70.5 in 2011, you would have until April l, 2012 to withdraw the required amount out of your account. Following this first withdrawal, you have until December 31st to take the required amount in each following year. Using the same example as before, you would have to make your first withdrawal by April 1, 2012, and then your second withdrawal by December 31, 2012 and each year thereafter.
At this point, you’re probably wondering just how much you are actually required to take from your account. The amount that you are required to take is based off of the value of your account at the end of the previous year, and is calculated based on a specific distribution period or life expectancy. Since the value of your account fluctuates, the amount that you have to take from your account fluctuates each year as well.
Despite all of these rules and requirements, the IRS has been kind enough to grant account holders some flexibility with RMD’s. You are free to take your distributions at any frequency that you would like- monthly, quarterly, one lump-sum, and so on- just as long as the total amount distributed is no less than the required amount. You are also free to select the date of the distribution (but subject to the previously mentioned deadlines) if you have a time of year that having the extra cash might be helpful, such as around the holidays. If you have multiple IRA accounts, you are required to calculate the RMD separately for each account, but you are free to either take the required amount from each individual account or to take the total aggregate required amount from one or more IRA accounts of your choosing. Finally, you are free to take more than this minimum amount from your account if you wish to.
Above all else, don’t forget to take the RMD! IRS penalties for missing the withdrawal or for not taking enough out are quite severe- 50% of the required amount that isn’t withdrawn will go to Uncle Sam as penalty!
As always, there are exceptions to the rules for certain account types such as Roth IRA accounts or some retirement plan accounts if you’re still working beyond age 70.5, so be sure to contact your tax advisor and Wealth Manager/Financial Advisor/Banker to discuss your specific situation.