How to Calculate Required Minimum Distribution (RMD)
One of the biggest advantages to investing in a qualified retirement plan like a 401(k) or an individual retirement account (IRA) is tax-deferred growth on your savings. But you can’t keep avoiding taxes by keeping your money locked up in these plans forever. At some point, Uncle Sam wants his cut. That’s why the IRS established required minimum distributions (RMDs). This is the amount you must withdraw from these accounts each year after you reach age 70.5. But how do you calculate your RMD? Read on to learn all about RMDs and how to calculate your withdrawals so you won’t face a severe penalty.
What is a Required Minimum Distribution (RMD)?
An RMD is the minimum amount of money you must withdraw from a tax-deferred retirement plan and pay ordinary income taxes on after you reach age 70.5. The IRS defines age 70.5 as six calendar months following your 70th birthday. Once you reach this milestone, you generally must take an RMD each year by December 31. We’ll explain the exceptions and how to calculate RMD. But first, let’s see what types of plans require RMDs and which don’t. RMDs apply to the following retirement plans:
Traditional IRAs
SEP IRAs
SIMPLE IRAs
Rollover IRAs
Most 401(k) and 403(b) plans
Most small business accounts
However, RMDs don’t apply to Roth IRAs, because contributions to these accounts are taken from your paycheck after it has been taxed.
RMD Tables
To calculate your RMD, start by visiting the IRS website and access IRS Publication 590. This document has the RMD tables (example below) that you will use to calculate your RMD. Then, take the following steps:
Locate your age on the IRS Uniform Lifetime Table
Find the “life expectancy factor” that corresponds to your age
Divide your retirement account balance as of December 31 of the previous year by your current life expectancy factor
IRS Uniform Lifetime Table Age Life Expectancy Factor 70 27.4 71 26.5 72 25.6 73 24.7 74 23.8 75 22.9 76 22.0 77 21.2 78 20.3 79 19.5 80 18.7 81 17.9 82 17.1 83 16.3 84 15.5 85 14.8 86 14.1 87 13.4 88 12.7 89 12.0 90 11.4 91 10.8 92 10.2 93 9.6 94 9.1 95 8.6 96 8.1 97 7.6 98 7.1 99 6.7 100 6.3 101 5.9 102 5.5 103 5.2 104 4.9 105 4.5 106 4.2 107 3.9 108 3.7 109 3.4 110 3.1 111 2.9 112 2.6 113 2.4 114 2.1 115 and over 1.9
Take note that calculating your RMD works a bit differently if your spouse is the only primary beneficiary to your account and more than ten years younger than you. In this case, you must use the IRS Joint Life and Last Survivor Expectancy Table. You can also find this on IRS Publication 590. However, your life expectancy factor would be based on the ages of you and your spouse. But the formula doesn’t change. You’d still follow the same IRA withdraw rules listed above.
If you have multiple retirement plans such as a 401(k) and a Roth IRA, you need to calculate RMDs for each plan separately. However, you can combine your RMDs and withdraw the total amount from just one plan or from any combination of the plans you own.
Luckily, most retirement plan record-keepers help you calculate your RMDs properly. But keep in mind that no law requires them to do so. Still, you can find a financial advisor for professional guidance in order to avoid IRS penalties. These can be severe.
What if I Don’t Take an RMD?
If you don’t make a proper RMD by the appropriate deadline, Uncle Sam will tax you 50% of the difference between the amount you withdrew that year and the amount you were supposed to take out that year.
However, you don’t have to take your RMD in one lump sum. You can take it in increments throughout the year. Just make sure you meet the proper RMD for that year by the appropriate deadline. In some cases, you can delay RMDs.
RMD Deadlines and Exceptions
If you have a non-Roth IRA, you may delay taking your first RMD until April 1 following the year you turn 70.5. But keep in mind that this applies only to your very first RMD from a non-Roth IRA. The deadline for each additional RMD will be Dec. 31.
Another point to consider is that delaying your first RMD until April 1 following the year you turn 70.5 essentially means you must take two RMDs that year. So let’s say you have a traditional IRA and turn 70.5 in June 2019. You can take your first RMD by April 1, 2020. However, you must also take another by Dec. 31, 2020. Remember, IRA withdrawals are taxed as regular income. So taking this route may bump you to a higher tax bracket, which can trigger other consequences.
To learn how this move would affect you based on your individual tax situation, you should seek a financial advisor or tax professional in your area.
However, the IRS provides some wiggle room when it comes to 401(k) plans and other employer-sponsored accounts. If you’re still employed by the company that sponsors your 401(k) plan and you don’t own 5% or more of that company, you can delay making your first RMD until after you retire. But if you leave that company after you turn 70.5, you must start taking RMDs.
To calculate your 401(k) RMD, you would use the same tables and take the same steps as you would for calculating your traditional IRA RMDs.
So far, we’ve covered how RMDs apply to accounts in your name. But RMD rules apply differently to beneficiaries who inherit the assets in your retirement account. Don’t worry. We’ll explain these in plain English.
RMDs and Inherited IRAs
If you’ve inherited an IRA, the RMD rules you must follow depend on your relationship to the original deceased owner. There are three general types of inheritors: a spouse, a non-spouse (such as a son or daughter) and an entity such as a trust or non-profit organization. It’s important to know the RMD rules behind these accounts in order to avoid the top mistakes people make when inheriting retirement accounts.
Let’s start with the rules for a spousal inheritor, who has rights not granted to all other types of beneficiaries.
RMD Rules When a Spouse Inherits a Traditional IRA
If you inherit an IRA from your deceased partner, you can roll over the assets into your own IRA. Or, you can rollover the assets into what is known as an inherited IRA as all other types of beneficiaries can. If you rollover assets into your own IRA, you can use the favorable Uniform Life Expectancy Table to calculate RMDs after you turn 70.5.
In addition, you get another exclusive benefit. If you’re better than 59.5, you can begin withdrawing money from your IRA without facing the 10% IRS early-withdraw penalty.
But if you’re under the age of 59.5 and want to start taking distributions, you might want to rollover the assets into an inherited IRA. Why? Because you can withdraw money from an inherited IRA without facing the 10% early-withdraw penalty no matter what your age is.
And you’d calculate the RMDs for an inherited IRA based on your age and life expectancy factor in the IRS Single Life Expectancy Table.
But when would you need to start taking RMDs from an inherited IRA? It depends on the age of your spouse at the time of his or her death. We explain below.
If your spouse was older than age 70.5: start taking RMDs by Dec. 31 on the year after your spouse’s death.
If your spouse was younger than 70.5: you can delay RMDs until your spouse would have reached age 70.5.
RMD Rules When a Non-Spouse Inherits a Traditional IRA
If you’re a non-spouse beneficiary such as a son or daughter, you must rollover assets into an inherited IRA. And you’d generally have to start taking RMDs by Dec. 31 of the year proceeding the death of the original account owner.
You would use the IRS Single Life Expectancy Table to calculate your first RMD. If the original owner died on or after reaching age 70.5, you would use the lower of the following along with its corresponding life expectancy factor.
Beneficiary’s age
Owner’s age at birthday for year of death
The IRS then requires you to subtract 1 from this initial life expectancy factor when calculating RMDs for each following year. You can also take the owner’s RMD during the year of his or her death.
But what if the account owner died before reaching age 70.5? In this case, you would use what your own age would be at the end of the year following the year of the original account owner’s death to figure out the life expectancy factor. You then subtract 1 from the initial life expectancy factor when calculating additional RMDs.
Sound complicated? Another option, regardless of what kind of relationship you had with the original owner, is much simpler. You can delay RMDs as long as you empty the account by the end of the fifth year following the year the original account holder died.
In the case of multiple non-spouse beneficiaries, each one would have to set up an inherited IRA by Dec. 31 following the year the original account owner died. Those who fail to do so would generally need to calculate their RMDs based on the oldest remaining beneficiary as of Dec. 31.
RMD Rules When an Entity Inherits a Traditional IRA
If you have a traditional IRA, you can designate a beneficiary to be an entity instead of an individual. Examples include trusts, charities, and certain organizations. However, this doesn’t mean they avoid RMD rules. In this case, the RMD depends on the age of the original account owner upon death.
So let’s say the original account owner was still alive by April 1 following the year he or she reached age 70.5. In this instance, RMDs will be calculated based on the life expectancy factor of the original owner using the IRS Single Life Expectancy table.
Now, consider the account owner died before turning age 70.5. In this case, the entity must withdraw the entire balance in the account by Dec. 31 of the fifth year following the year of the original account owner’s death.
However, exclusive rules apply to Look-Through Trusts. You should consult a financial advisor and tax professional for specific guidelines on how the IRS treats RMDs in this case.
RMDs and Inherited Roth IRAs
One of the major advantages to investing in a Roth IRA is that you can keep your money in the plan indefinitely. The IRS doesn’t impose RMDs on these accounts as long as you’re alive. That may change, however, when you pass away and someone inherits your assets.
So let’s explore the basics.
RMD Rules When a Spouse Inherits a Roth IRA
Under IRS rules, a surviving spouse who inherits a Roth IRA can treat the account as his or her own. This means RMDs won’t come into play. So it’s best to rollover the inherited Roth IRA as soon as possible if the process isn’t automatic under the original owners agreement.
RMD Rules When a Non-Spouse Inherits a Roth IRA
If you’ve inherited a Roth IRA from anyone who is not your legal spouse, you’d be subject to RMD rules. In this case, you have two choices.
Option One: Withdraw the entire balance from inherited Roth IRA by December 31 of the fifth year after the original owner’s death.
Option Two: Begin taking RMDs based on your Single Life Expectancy by December 31 of the year following the original owner’s death.
If you don’t begin taking RMDs as outlined in Option 2, you will be subject to the rules of Option 1. So to take the second option, you should file a Term Certain Method agreement with the plan’s administrator as soon as possible.
RMDs and Inherited 401(k)s
By law, the beneficiary to your 401(k) account must be your spouse unless you’re single or your spouse signs a waiver. If you inherit a 401(k) from a deceased spouse, you can leave it in the plan as long as the company sponsoring it allows it. Or you can roll over the assets into an inherited IRA. In this case, you will be subject to the RMD rules that apply to spousal inherited IRAs as described above. Likewise, a non-spousal beneficiary who rolls over inherited 401(k) assets into an inherited IRA will abide by the applicable RMD rules stated above.
Keep in mind, however, that some companies impose stricter restrictions on how money in their employees’ 401(k) plans can be moved around. Some, for instance, may require beneficiaries to take the money out of the account in a lump sum or over the course of five years. You should contact the plan administrator for complete plan rules.
In addition, state laws may affect inherited 401(k) assets as well. And depending on how much is in the account, estate and inheritance tax laws may come into play as well. In the case of handling inherited 401(k) assets, it’s best to seek a tax and financial advisor in your area.
How to Avoid RMDs
One of the easiest and perfectly legal ways to avoid RMDs is to rollover your IRA or 401(k) assets into a Roth IRA or Roth 401(k). The IRS doesn’t require you to take RMDs from these accounts. Theoretically, you can leave money in a Roth IRA or Roth 401(k) forever, and it can continue growing tax-free. But as long as your assets have been in these accounts for at least five years, you can make tax-free and penalty-free distributions after reaching age 59.5. And at any time, you can withdrawal your own contributions penalty and tax free.
The Takeaway
An RMD equals the minimum amount of money you must withdrawal from most retirement plans after reaching age 70.5. Calculating your RMD can be as simple as looking at a table and grabbing a calculator. Remember, you have the entire year to meet your RMD. But it can be complex under certain circumstances. So it helps to do your home work, especially since IRS penalties can be stiff.
Tips on Avoiding RMD Penalties
Make sure you make the required RMD by the appropriate deadline. But don’t worry. Most people satisfy their RMDs and then some within a given year, especially during retirement. And to help you avoid some pitfalls, our retirement experts published a report on tips for understanding required minimum distribution rules.
As you can see, the world of RMDs can be extremely complicated in certain cases. And because these involve taxes and potential IRS penalties, working with a financial advisor can save you a lot of headaches. If you’ve never worked with one, we can help. Our SmartAsset financial advisor matching tool gives you access to up to three financial advisors in your area. You can take a glimpse at their profiles and credentials to see if you’d like to work with one.
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