Traditional and Roth Individual Retirement Accounts (IRAs) are both vital retirement savings plans that most people have access to whether or not they are signed up for another plan such as a 401(k) plan at work.
Both types of IRAs provide some tax benefits on the money you put into them, but they differ in some ways. Internal Revenue Service (IRS) rules dictate that you can't just let your money sit in your retirement accounts without taking any money out once you retire. IRS rules state that you must take required minimum distributions (RMDs) from accounts you receive tax breaks for or pay a steep penalty.
Knowing that traditional and Roth IRAs have RMDs and how to satisfy RMD rules can help you choose the right account for your financial needs when you retire.
RMDs Apply to Traditional IRAs
Certain retirement plans, namely 401(k) plans, traditional IRAs, SIMPLE IRAs, and SEP IRAs, require people to begin to withdraw money from their accounts once they reach age 70.5. For those who turn 70.5 after July 2019, they now have until age 72 to begin taking money out of their account. These RMDs dictate the least amount that you must withdraw from your account every year.
The RMDs are included in the retiree's taxable income and are therefore subject to income taxes. Because tax-deductible accounts such as traditional IRAs allow you to deduct the money you put into it and defer taxes until you retire, RMDs give the IRS the chance to collect tax on money that was tax-free up until this point. For this reason, any portion of a withdrawal that was taxed before should be treated as tax-free (Roth money rolled into a 401(k) account, for example) won't be counted as taxable income.
If you intend to rely on the proceeds of your traditional IRA in retirement, the RMD rule may not matter to you as you may need to begin using that money well before the RMD starting age. In fact, you may need to withdraw more than the required minimum to make ends meet in retirement. This is fine because, as the name suggests, RMDs are simply the least amount you have to take out.
But for retirees who have other sources of income or who may not need to spend the money in these types of accounts after the RMD starting age, this rule will trigger income taxes. Because a portion of the funds will no longer be in the IRA account after you start taking RMDs, the chance for future tax-deferred growth on those funds is lost.
RMDs are a requirement for traditional IRAs, SIMPLE IRAs, SEP IRAs, and 401(k) plans.
RMD Rules for Traditional IRAs
Even if you are still working, you must take your first RMD from a traditional IRA, SEP IRA, or SIMPLE IRA by April 1 of the year after the year in which you turn 70.5 or 72, depending on your current age.
If you turn 70.5 in 2020 or afterward, you'll have to take your first RMD by April of the year following the calendar year in which you turn 72. But if you reached age 70.5 in 2019 or before, you would have to take your first RMD by April 1 of the year following the calendar year in which you turned 70.5. For all the years after, including the year in which you took the first RMD by April 1, you must take the RMD by December 31 of the year.
If you don't begin to take money out of the account, or you withdraw a lower amount than you must take, you'll get hit with a 50% excise tax on the difference between the amount you withdrew and the amount you should have withdrawn. You may also have to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. To make matters worse, you'll still have to withdraw the required amount and pay any income tax due on the taxable amount.
The CARES Act waives the requirement to take RMDs from IRAs and other retirement plans for 2020, including your first RMD.
How to Find Out Your Traditional IRA RMDs
The IRS offers RMD tables to help you figure out the amount of your initial RMD and the ones that come later. You can find all tables in the IRS's Publication 590-B.
- Single Life Expectancy (Table I): Use this table to find out your IRA RMDs if you are taking payments as a non-spouse beneficiary.
- Joint Life and Last Survivor Expectancy (Table II): Look to this table if you have a spouse who is more than 10 years younger than you.
- Uniform Lifetime (Table III): Figure out your RMD using this table if your spouse isn't more than 10 years younger than you.
Obtain your estimated life expectancy from the first two tables or the distribution period from the third table. Then, use Appendix A, Worksheet for Determining Required Minimum Distributions, to find out when you need to take your first RMD. You will need to divide your IRA account balance by your life expectancy or distribution period to obtain your RMD. The account balance you'll use to figure this out should be what it was on December 31 of the prior year.
Roth IRA RMD Factors
Roth accounts have some of the same tax benefits as traditional IRAs, but they differ in some crucial ways as well. With a Roth IRA, you are putting post-tax money into your account. While you can't deduct money you put into your Roth IRA from your income taxes, the earnings you get from it grow tax-free. Since you paid tax on the money before you put it in the account, you pay no tax on it when you take it out when you retire.
Another good aspect of Roth IRAs is that they don't require RMDs during the account owner's lifetime. This means they are not subject to the RMD. Even people older than the starting RMD age do not have to take money out of their Roth IRAs.
As in the case of traditional IRAs, this exception from RMD rules for Roth IRAs may not affect you if you intend to start taking from your Roth IRA before the RMD starting age. For those who may not need to withdraw funds from their Roth IRA to live off of when they retire, a Roth IRA provides a great chance to allow your earnings to keep growing tax-free. You may even be able to pass the money from your account to your heirs.
Inherited Roth IRA RMDs
While IRA account owners don't have to take RMDs during their lifetime, if you inherit a Roth IRA, then you do have to take RMDs as laid out in the same rules that govern RMDs for traditional IRAs. You would have to take out your RMDs as though the account owner had died before his required RMD start date.
If you're a spouse beneficiary, you can:
- Treat the Roth IRA as your own. You would need to appoint yourself as the account owner if you choose this option.
- Take out the entire amount by the fifth year after the owner's death.
- Figure out and take your RMDs based on Table I. You don't have to start taking out money until the owner would have reached their RMD starting age.
As a non-spouse beneficiary, you can:
- Withdraw the full balance by the fifth year following the owner's death.
- Figure out and take your RMDs based on Table I.
The Bottom Line
Both traditional and Roth IRAs provide tax breaks. Roth IRAs impose no taxes on amounts you take out, while traditional IRA withdrawals are taxed.
Roth IRAs also impose no RMDs on account owners during their lifetime. They grant retired people the flexibility to spend their account assets when they want. People must take money out of their traditional IRAs when they get to the RMD age, as laid out in the rules.
Tax-free growth ceases in a traditional IRA when RMDs begin. If you expect to have other income sources when you stop working, you may want to put money into a Roth IRA along with or instead of a traditional IRA. Roth IRAs have an edge in this case as they allow you to keep growing your account assets tax-free or even pass on your wealth to your heirs.
- The IRS requires you to begin taking money out of certain retirement accounts after age 72. This is called the required minimum distributions (RMDs).
- Traditional 401(k) plans and IRAs, SIMPLE IRAs, and SEP IRAs all require RMDs.
- Roth IRAs don’t require RMDs.