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Tax-deferred retirement bills can protect your nest from Uncle Sam while you work. But in the end you have to pay income tax from your pension funds, which is why those annoying minimum distributions (RMDs) occur when you turn 72 years old.
It is crucial to understand how to calculate the exact amount of RMD each year, as withdrawing a distribution that does not comply with the IRS can have serious tax consequences. Here’s what you need to know about calculating RMD.
How to calculate your RMD
Let’s calculate yours RMD for this year, the first step is to determine the balance on each of your tax-deferred retirement accounts on December 31 of the previous year. (Noticeably, Roth IRA balances, although not other balances on Roth accounts, can be exempted because they are already taxed.) Once you have your balances in hand, add them together and divide the total amount by your IRS expected life factor.
What is the factor in the life expectancy of the IRS? This key RMD figure represents the number of years you are expected to live, according to actuarial calculations. It is also called the distribution period, and is based on your current age. You can find your life expectancy factor in IRS Unique Lifetime Table.
Here is an example of a typical RMD calculation. Take Hannah, a single woman who turns 72 in 2021. Its amount of 401 (k) had a balance of $ 250,000 as of December 31, 2020. The Uniform Lifetime Table lists Hannah’s distribution period as 25.6 years. By dividing its balance sheet by the distribution period, it receives an RMD of $ 9,765.63. ($ 250,000 / 25.6 = $ 9,765,625, rounded to $ 9,765.63).
You can always take larger distributions than those resulting from the above calculations, but the minimum portion of the required minimum allocation tells you that this is the smallest withdrawal you can make to meet IRS requirements. Unfortunately, you cannot use withdrawals above the minimum in one year to meet RMDs in subsequent years.
The tax administration charges severe penalties for taking too little RMD. If you take less than you need, the IRS will take 50% of the difference between what you withdrew and what you should have withdrawn. For example, if Hannah withdrew only $ 7,000, the IRS would charge $ 1,382.81 in excise duty – half of $ 2,765.62, which is the difference between what she actually took and her minimum distributions.
RMD rules for multiple retirement accounts
If you have multiple retirement accounts, you need to follow certain ones rules about how to withdraw your RMDs.
If you have multiple accounts with defined contribution plans, like several 401 (k) from different employers, you need to calculate a specific RMD for each account and pick up the exact amount from each. Your 401 (k) plans and other defined contribution plans will often calculate your RMD for you, but to simplify things, you can consolidate your 401 (k) into one account or even transfer your savings to a single IRA.
If you have multiple IRAs, you can raise your total RMD amount from one IRA or a portion from each of your IRAs. Unlike defined contribution plans, you do not have to take separate RMDs from each IRA.
Exceptions to RMD rules
Some RMDs are calculated slightly differently from what is stated above. Specifically, if you are married to a spouse who is more than 10 years younger than you, or if you are a beneficiary of a retirement plan after a plan participant dies, then you will use another method to calculate your RMD.
RMD rules of spouses
If you are married to a spouse whose date of birth is within 10 years of you, your RMD will be calculated using the Single Lifetime Table, just as it is for individual account holders. However, married account holders with a spouse who is 10 or more years younger and whose spouse is listed as the sole beneficiary must use Table of the joint life of the IRS and the expected survivor to calculate the correct RMD.
The period of distribution on the Table of Cohabitation and Expected Survivor is based on the age of both spouses. For example, if Frank is 74 and his wife Mary is 60, the Common Living Table lists their combined distribution period as 26.6. If Frank’s IRA balance as of December 31 last year is $ 400,000, his RMD is $ 15,037.59. That’s significantly less than $ 28,368.79, as much as the Uniform Lifetime Table would force him to withdraw.
RMD rules for inherited plans
If the owner of the pension account dies without taking the required RMD for a year, it is up to the heir to take over the RMD in order to avoid a tax penalty. Once taken care of, you have a little more flexibility in terms of the timing of future withdrawals, assuming you withdraw all assets by December 31, 10 after the death of the original IRA holder.
These withdrawals will be taxed as ordinary income unless they come from a Roth account. In that case, they will not be taxed at all until the account holder first funded the Roth account at least five years before their death.
Exceptions to the rules of the inherited plan
If you are the spouse or minor child of the original account holder, no more than 10 years younger than the original account holder, or you are disabled or chronically ill, you have additional withdrawal options for an inherited retirement plan.
You can still decide to expand the withdrawal for 10 years. Or you can opt for a five-year or lifetime distribution. (Note: When minor children reach the age of majority in their country – usually 18 or 21 years old), they must liquidate the inherited account within 10 years.)
With a five-year distribution, beneficiaries must withdraw all pension account assets by December 31 of the fifth anniversary of the account holder’s death. If multiple users are named for a single account, they will have to use the five-year allocation rule if the original account holder died before they started taking RMDs (that is, before they turned 72).
For lifelong distribution, the user determines the RMD based on the indication of their age in Table of life expectancy individually. That is, if the named sole user is not the spouse of the original account holder. In this case, the spouse can effectively become the new primary account holder and calculate RMDs using the Single Life Table. However, if the spouse is not the sole beneficiary, they must use a single life expectancy table, using the age of the oldest beneficiary to calculate the RMD.
Frequently Asked Questions
The RMD or required minimum allocation is the minimum amount you must withdraw from a qualifying pension account each year.
Once you turn 72, almost all retirement accounts are subject to RMDs, including:
Because you pay income tax in advance, Roth IRA are the only tax deferral plans that do not require RMDs. This fact is another reason why many retired savers try to inject as much money into the Roth IRA as possible. You can avoid the RMDs required for Roth 401 (k), 403 (b), and 457 (b) plans rolling out your employer-sponsored accounts in the Roth IRA at any time. If you want to avoid RMDs with Roth’s traditional account switching, you’ll be required to convert the conversion tax.
When do you need to take RMDs?
Until the passage SAFE law in 2019, the mandatory age for taking RMD was 70½. Retirement reforms moved the start date of the required minimum distributions to 72 years for all born on or after July 1, 1949.
You must withdraw your annual RMDs by December 31 of each year, although you can postpone your first RMD until April 1 of the year following the year you are scheduled to begin drafting the RMD.
However, if you wait to take out that initial RMD, you will need to take two RMDs next year – one by April 1st and one by December 31st – and that means paying income taxes in both distributions in one year. Depending on the size of your RMDs, taking two in one year could have the side effect of pushing you into a higher income tax bracket.
How can you minimize RMDs?
Getting the right RMDs is an important part of maintaining healthy retirement finances. But if you ask minimize your RMDs—And therefore your retired tax bill — you have several options:
- Continue working after 72 years. If you continue to work for an employer that sponsors your 401 (k) and do not own more than 5% of the company, you are not required to take RMDs.
- Roth IRA conversion. Since RMDs are not required for Roth IRAs, converting a traditional IRA to a Roth can help you minimize your RMDs, although keep in mind that you will be taxing the amount you convert to a Roth IRA.
- Qualified charity distribution. If you donate your RMD to a qualified charity, you will not be liable to tax on the amount of RMD without continuing to meet your distribution requirements.