What are Required Minimum Distributions (RMD)
As individuals approach retirement age, it is important to plan for future tax changes as a result of their retirement accounts, and age. The American retirement system is highly age based, with everything from when you can start your social security benefits, from penalty free retirement withdrawals. Another important age in the retirement system is currently 72, the age you will need to begin your required minimum distributions (RMDs). So, let’s take a closer look at RMDs.
What are RMD's?
RMD's are the minimum amount that an individual must withdraw from their retirement account each year, beginning at the age of 17 for those born on or after July 1st 1949. RMD's apply to traditional IRA's simplified employee pension plans (SEP), SIMPLE IRA plans, 401K and 403B plans, and other defined contribution plans.
The purpose of RMD's is to ensure that individuals withdraw a portion of their retirement savings each year, as the government wants to ensure that people are not simply hoarding their money in tax advantage accounts without using it to fund their retirement.
How are RMDs calculated?
The IRS provides tables that are used to calculate RMD's based on an individual's age and the balance of their retirement account(s) at the end of the previous year. The RMD amount is calculated by dividing the account balance by the life expectancy factor provided in the IRS tables.
For example, suppose an individual is 75 years old and has a retirement account balance of $500,000 at the end of the previous year. They would look up their life expectancy factor in the IRS table, which would be 17.2. They would then divide their account balance by their life expectancy factor to arrive at an RMD of $29,069.76. The catch with RMDs and something that causes problems for people in retirement, is that they have to withdrawal this amount, whether or not they need the full value of their RMD amount.
What happens if RMDs are not taken?
Failing to take RMD's can result in significant penalties. If an individual fails to take their RMD, the amount that should have been withdrawn is subject to a 50% penalty tax. For example, if an individual has an RMD of $10,000 and failed to withdraw it, they would be subject to a penalty of $5,000.00.
It is important to note that Roth IRAs are not subject to RMD's, and Roth IRA distributions are generally tax free as long as certain requirements are met. Therefore, individuals who do not need to withdraw from their Roth IRA for living expenses may choose to leave the account untouched to continue to grow tax free.
To sum it all up, RMDs are an important aspect of retirement planning, as they ensure that individuals withdraw a portion of their retirement savings each year. While RMD's may sound complex to calculate, most institutions will do this for you, but it is important to take them seriously and to plan for them accordingly to avoid penalties and unnecessary future taxes.
Sources:
https://www.irs.gov/publications/p590b#en_US_2021_publink100089977
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