What is a Required Minimum Distribution?

July 23, 2019

Tax-deferred retirement saving is one of the best tools for saving for your retirement, but at some point, you have to start withdrawing your retirement funds - even if you're still working. This is known as taking the Required Minimum Distribution (RMD), and the IRS has strict guidelines to force these withdrawals. (The reason is simple - these withdrawals, typically from funds that haven't been taxed, will be included in your taxable income.)

What is it?
With most tax-deferred retirement plans (i.e. traditional IRAs, 401(k)s, etc), you're legally required to start taking RMDs at 70 ½. One notable exception is the Roth IRA, which doesn't have RMDs. (Interesting side note - a Roth IRA account owner is never legally required to withdraw funds from the account.)

You can start making withdrawals before 70 ½, usually starting at 59 ½, without early withdrawal penalties. Your withdrawals will be included in your taxable income, unless the funds were taxed before they were deposited into the account or it's a qualified distribution from certain account types. You can withdraw more than the minimum amount, though you should do your homework to know how different amounts will affect your taxes.

How is this amount determined?
The IRS has a formula for determining the RMD, which is based on the total amount saved, your current age, and your life expectancy factor (which they define based on your age). In most cases, your retirement plan custodian (i.e. your brokerage firm, bank, mutual fund company, etc) will calculate the RMD from that account for you. (If you have multiple plans with different custodians, you'll hear from each of them - they do not combine accounts with different custodians.) You should receive an annual statement telling you how much you need to withdraw along with the deadline.

What if you don't take the RMD?
Most retirees are not impacted by RMD rules, as most begin taking disbursements before they reach 70 ½ and are receiving more than the RMD. However, if you fail to take the RMD, you'll be charged an excise tax on the amount not distributed as required. This tax can be up to 50% - one of the harshest penalties assessed by the IRS. This provides ample incentive to stay on top of your RMD.

Are there any exceptions?

If you're still working and contributing to a qualified retirement plan (like a 401(k)), you may be permitted to delay taking your RMD, but it will depend on the rules of your plan. This is certainly an area where you will want to reach out to your plan administrator and CPA for guidance - no one wants to give the money they've worked so hard to save to the IRS.

The bottom line?
You've worked hard to save for your retirement, and want to make the most of those funds. It pays to be informed of the IRS rules for retirement plans, and to verify that your financial advisors are as well.