How Your Life Expectancy Affects Required Minimum Distributions

Your Life Expectancy Affects How Much You Must Withdraw From Your IRA

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You probably understand the tax advantages of various retirement accounts if you've been saving throughout your career, but transitioning from the "accumulation phase" to the "distribution phase" of retirement requires a special understanding of IRS rules. 

These rules include required minimum distributions (RMDs). You're obligated by law to begin taking RMDs from your 401(k), traditional IRA, or other qualified retirement plan every year beginning no later than April 1 of the year following the year you reach age 70½. Then you must take RMDs by December 31 in each subsequent year. The amount of your RMDs is based on your life expectancy. 

Why Are Minimum Distributions Required?

RMD rules exist because of the tax benefits provided by qualified retirement plans. Plans like 401(k)s, traditional IRAs, and SEP IRAs all offer tax deductions on contributions you make, up to a limit. They also offer tax-deferred growth on the contributions' earnings. 

These incentives and benefits not only encourage people to save for retirement, but they also increase the overall growth on these retirement assets for tomorrow. But the Internal Revenue Service still wants its share of those dollars at some point in time.

RMDs essentially ensure that the IRS will eventually get to tax the assets in your retirement accounts by requiring that you take distributions that are added to your taxable income each year. Your withdrawals less your basis—any contributions which you might have already paid taxes on—are included in your taxable income for the year you take them.

These rules apply to all employer-sponsored plans, as well as Roth 401(k) plans, but not Roth IRAs. Inherited Roth IRAs do have minimum distribution requirements, however. 

How to Calculate Required Minimum Distributions

Many plan custodians will provide your calculated RMD for you, but they're not required to do so. And it's not a highly complicated equation so you can easily do it yourself. Your RMD amount is calculated by dividing the balances of all your qualified accounts as of December 31 of the previous tax year by your life expectancy factor.  

So how do you find your life expectancy factor? You can look it up on the IRS Uniform Lifetime Table. It's published on numerous sites online. Use this table unless your spouse is your sole beneficiary and is more than 10 years younger than you. In that case, you would use the joint and survivor tables instead, available in IRS Publication 590.

An Example

Let's assume you turned 70½ in 2018. You had a combined IRA and 401(k) balance of $274,000 on the last day of 2018. As a single individual, you would use the distribution factor found in the IRS Uniform Lifetime Table, which is 27.4, assuming you had not yet reached age 71 on the last day of 2018.

Your required 2018 RMD would therefore be $10,000 for 2019: $274,000 divided by 27.4. You would have until April 1 of the first year to take at least that amount, but you might not want to wait that long.

Remember, these withdrawals are taxed in the year you make them, and the April 1 extension only applies to the year in which you reach age 70½. When you celebrate your 71st birthday in the next year, you must take an RMD by December 31.

If you wait until the April of the year following your 70th birthday, you'll effectively have to take two RMDs that year, and this could bump up your taxable income considerably, resulting in paying more taxes in a given year than you had to. Many retirees take their first RMD by December 31 of the year in which they reach age 70½ for this reason. 

If You Have Multiple Accounts 

You can take your RMDs from one or more traditional IRA plans if you have more than one account. For example, if you have to take $10,000, you have the flexibility of taking $5,000 from Account A and $5,000 from Account B. But RMDs must be calculated on and taken individually from any 401(k) or 457(b) plans that you have.  

If You Fail to Take an RMD

The penalty for failing to take an RMD by the required deadline is significant—50 percent of the amount that you didn't take. You must also file IRS Form 5329, Additional Taxes on Qualified Plans, along with your tax return for that year. 

The penalty might be waived, however, if you throw yourself on the mercy of the IRS and you can establish that your failure to take a distribution was due to "reasonable error." You must be able to show that you're taking steps to rectify the situation. Attach a letter explaining the circumstances to Form 5329 when you submit it. 

For most retirees, RMD rules have no special impact on how their retirement funds are used. Many begin taking withdrawals from their accounts as a means of retirement income before age 70½. But you should know the amount of your personal RMD to ensure that you're not at risk for the steep 50 percent penalty tax that's assessed if you don't take one on time. 

You can take more than the minimum required. You're not limited to your RMD, but you can't apply any additional funds you take to future years' RMDs. And you don't have to actually spend the money you take. You can reinvest it in another type of account as long as the new account isn't tax-deferred.