How Do RMDs Work?

RMDs are a way to force you to pay taxes on pre-tax money after you reach age 72, and are critical to understand for a successful retirement plan.

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By Michael Sharpnack

How Do Required Minimum Distributions (RMDs) work?

Required Minimum Distributions (RMDs) are withdrawals you are required to make from certain types of accounts after you reach age 72 (for most people). 

The government created these rules to keep you from deferring taxes forever. They force you to take the money out each year so you pay taxes rather than letting it continue to grow tax-free.

You can choose to do whatever you want with the money once you withdraw it except put it back into the account.   

The RMD rules apply to qualified retirement plans (except for Roth IRAs). 

Common accounts subject to RMDs:

• Traditional IRAs
• Simple IRAs
• SEPs
• 401(k)s
• 403(b)s
• 457(b)s
• Profit-sharing plans
• Certain defined contribution plans

While Roth IRAs are not subject to the RMD rules, Roth 401(k)s, Roth 403(b)s, and Roth 457(b)s retirement plans are.

RMD Penalty

If you don’t take your full RMD, then you pay a 50% penalty tax on the amount not withdrawn.  

For example, if your RMD was $1,000 but you only withdrew $500, then you would pay a 50% penalty on the remaining $500. Thus, $250 would go to the IRS. 

When Do RMDs Start?

With the passage of the SECURE Act in 2019, RMDs start with two scenarios.

1. For most people, RMDs start at age 72.
2. If you were 70 1/2 before January 1, 2020, then you’re already subject to RMDs.

One exception: Employer-sponsored retirement plans—like 401(k)s and 403(b)s—have a still-working exception: If you still work for the employer when you reach the age for RMDs, then you may qualify, which allows you to delay RMDs until you stop working. But you should consult with your employer or tax professional to see if you qualify.

What Time of Year Do You Have to Take the RMD?

For all accounts (except inherited IRAs), you can take the RMD whenever you want in the year, but it must be withdrawn by December 31 of each year, except for your first year. 

The first year that you have an RMD, you have the option to delay it to the following year. But if you choose to delay it, then you must take two RMD distributions the next year. The first is due by April 1, the second by December 31.  

There is no option to delay after the first year.

Aggregating RMDs Out of IRAs

IRA accounts can be aggregated together for RMDs.

This includes traditional IRAs, SIMPLE IRAs, and SEP IRAs.

If you have multiple types of IRAs, you can total up the RMDs from each IRA, and take it from just one account if you want. If the RMD is $5,000 for a SIMPLE IRA, $10,000 from one traditional IRA, $2,000 from another IRA, and $8,000 from a SEP, you could take $25,000 from one of the traditional IRAs and satisfy your RMD requirements. 

However, employer plans, like 401(k)s and 403(b)s don’t aggregate. 

If you had a 401(k) and it was rolled into an IRA, it’s considered an IRA and does count toward the aggregation rules.

What to Do With Your RMD?

The main thing the government cares about is that you pay taxes on the money.

Once you take it out of the account and pay taxes on it, you can do whatever you want with it. 

If you need the RMD as income, you can put it in your checking account and spend it. You can take it in a lump sum or in monthly payments. 

If you don’t need it as income, reinvesting your RMD is a good idea. You can’t put it back into your IRA, but you can transfer it to a taxable account. It loses the tax-free growth of the IRA, but it stays invested in the market.

Any decision you make on your RMD should be coordinated with your retirement withdrawal strategy.

Most people choose to take the RMD as a lump sum toward the end of the year so it can stay in the market as long as possible. But if you’re living off the money, you may choose to take the RMD in monthly payments instead. You’ll just need to calculate the amount of the RMD at the beginning of the year, divide by 12, and then take that as a payment each month.

The account holder is responsible to take the RMD. A financial advisor or tax professional can assist, but it is ultimately the responsibility of the person who owns the account.

As standard practice for our clients, we notify everyone who has to take an RMD each year.

How Are RMDs Calculated?

RMDs are calculated by dividing the ending account balance (December 31) from the previous year by the correct distribution period from the IRS table.

RMD calculation: December 31 balance/IRS distribution period

The distribution periods are based on your life expectancy as determined by the IRS.

The Uniform Life Table is used for all IRA owners calculating their own withdrawals, married owners whose spouses are not more than 10 years younger, and married owners whose spouses are not the sole beneficiaries. 

Table II (Joint Life and Last Survivor Expectancy) is used for owners whose spouses are more than 10 years younger and are the sole beneficiaries.

Here’s the RMD Table, including percent of account balance (through age 95):

For example, say you’re 75 and your account balance on December 31 last year was $1,000,000.

1. Distribution period for a 75-year-old is 22.9
2. 1,000,000/22.9 = $43,668.12

Your RMD would be $43,668.12 for the year you turn 75.

RMDs do not stop, and they continue to go up in percent of account balance until it’s just over 50% when you’re 115.

Inherited RMDs

Inherited accounts also have RMDs, but the rules are much different—and much more complicated.

The basic rules:

Inherited Account From a Spouse

When you inherit an account from your spouse, you can roll it over and treat it as your own. 

In this case, once the money is in your own account, no additional inherited RMD rules exist. You are subject to the standard RMD rules mentioned above.

Inherited Account From a Non-Spouse

The SECURE Act, passed in December 2019, changed these rules.

First question: When did the person die?

For those who died in 2019 or prior, the beneficiary has the ability to spread RMDs throughout their lifetime. Say your uncle died in 2019 and you inherited his IRA. If the IRS determines your life expectancy to be 25 years, you could spread the RMDs throughout 25 years, increasing each year, but in the last year you would be required to take the entire account balance.

For any account inherited after 2020, however, the SECURE Act implemented a new 10-year rule.

Under the 10-year rule, the entire account balance must be withdrawn after 10 years. There’s no per year requirement—you can leave it in there until year 10 and take it all out then, or you can take a little out each year.

Aside from spouses, other exceptions to the 10-year rule are a disabled or chronically ill person, a child who hasn’t reached the age of majority, or a person not more than 10 years younger than the IRA account owner.

This covers the basics of the inherited rules. For a full understanding of the rules and options, see IRS publication 590-B.

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*Advisory services offered through Paul Winkler, Inc. (‘PWI’), an investment advisor registered with the State of Tennessee. PWI does not provide tax or legal advice: please consult your tax or legal advisor regarding your particular situation. This information is provided for informational purposes only and should not be construed to be a solicitation for the purchase of sale of any securities. Information we provide on our website, and in our publications and social media, does not constitute a solicitation or offer to sell securities or investment advisory services, or a solicitation to buy or an offer to sell a security to any person in any jurisdiction where such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.