What is a Required Minimum Distribution (RMD)?

What All Investors Should Know About Required Minimum Distributions

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A retired man using his laptop. Sam Edwards/Getty Images

Required minimum distributions, more commonly referred to as RMDs, are a congressionally-mandated distribution from a qualified retirement plan. These RMD rules dictate the minimum amount you must withdraw from their account every year beginning by age 70½. What the required minimum distribution rules come down to is that while the IRS will grant tax benefits on assets invested in a qualified retirement plan like a 401(k), traditional IRA, or SEP IRA, you cannot keep funds in those tax-advantaged accounts forever.

Eventually, the IRS is going to want to take its piece.

How Required Minimum Distributions Work

Required minimum distribution rules ensure that the IRS gets its opportunity to collect taxes on retirement money that up until the start of withdrawals had been deductible or tax-free up until this point.

For most retirees, RMD rules have no real impact on how they use their retirement funds, as most begin to take distributions well before age 70½ as a means of income in retirement. In fact, in addition to taking distributions before the required age, most retirees actually withdraw more than the minimum amount. But for those fortunate retirees who have other sources of retirement income or who might otherwise not spend the assets in their qualified retirement accounts, the RMD requirement kicks in and creates taxable income. And just like any other retirement income, you can put your RMD towards expenses, a taxable investment account, or even a monetary gift to charity.

The money is yours. The only thing you cannot do is reinvest the money into another qualified retirement account.

According to RMD rules, starting with the April 1 after you reach 70½ years old, you must take annual distributions from your qualified retirement plans, such as your 401(k) and IRA. The amount you must withdraw is based on the value of your accounts at the beginning of the year for which you are required to take a distribution.

That total is then divided by your life expectancy as determined by the IRS.

Penalties for Failing to Take Required Minimum Distributions

If you are still working and contributing to a qualified plan like a 401(k) at age 70½, you may be permitted to delay taking your required minimum distribution, but it will depend on the rules of your plan. Otherwise, by April 1 after you turn age 70½, you are required to start taking distributions that will be counted as part of your taxable income. If you do not taking your RMD, you will be subject to a steep penalty. The penalty for not taking your RMD is a tax of 50% on the amount that was not withdrawn in time.

How to Calculate Your RMD

Since your personal required minimum distribution is unique based upon your account value, you will want to use an estimate of the total value of your account at age 70½ to calculate an RMD estimate. Here are three of best RMD calculators to help you with that estimate. Many retirement plan custodians or financial planners will calculate your RMD for you, but they are not required to do so. When it comes time to make sure that you are taking appropriate distributions, be sure that you have the appropriate figures.

It is important to note that Roth IRAs are not subject to RMD rules unless they are inherited accounts, in which case different rules for distributions apply.