Required minimum distributions (RMDs) are IRS-mandated distributions from retirement accounts. Understanding how they work is important so you can make sure that you are in compliance with the rules. Here are seven things to know about RMDs.
When must you start RMDs?
Beginning on Jan. 1, 2020, the age at which RMDs from retirement accounts must commence was increased to 72. Prior to the date it was 70½. Those who had started their RMDs at age 70½ prior to Jan. 1, 2020 are required to continue their RMDs based on the old rules.
How are RMDs calculated?
RMDs are based on the account balance in your account(s) as of Dec. 31 each year. For example if you have a traditional IRA account, your balance as of Dec. 31, 2021 was used in calculating your 2022 RMD.
The account balance for the prior year-end is then matched against the appropriate IRS distribution table. For most people this is the Uniform Lifetime table, table 3. There are different tables if your spouse is 10 years younger than you or for those with a single life expectancy.
Using the Uniform Lifetime table, for someone who will reach age 73 in 2022:
- Dec. 31 balance in IRA $250,000
- Distribution period from table 3: 26.5 years
- RMD calculation for 2022: $250,000 divided by 26.5 = $9,433.96
This is the amount they would need to take as their RMD for 2022.
There are a number of good RMD calculators available online that can aid in calculating your RMD. Several years ago the rules on reporting RMD amounts to the IRS changed requiring IRA custodians and retirement plan administrators to calculate your RMD each year and communicate this number to the IRS. The custodian will also communicate this number to you as well.
What is the deadline for taking your RMD?
Your RMD must be taken by Dec. 31 each year. The exception to this is for your first RMD. You are allowed to defer taking this one until April 1 of the following year. For those turning age 72 in 2022, they can defer their first RMD until April 1, 2023.
It’s important to keep in mind that if you defer your first RMD until the following year, you will be taking two RMDs in the same calendar year as you will still need to take your regular RMD for the following year. You will want to look at the tax implications before deciding whether to defer your first year RMD.
Which accounts are subject to RMDs?
RMDs must be taken from all employer sponsored retirement plans, including:
- 401(k) accounts, both traditional and Roth
- 457 plans
- 403(b) plans
- Profit-sharing plans
RMDs must also be taken from traditional IRAs, SEP-IRAs, SARSEPS and SIMPLE IRAs. Defined-benefit pension plans are also subject to RMDs, but this requirement is generally met by annuitizing the benefit.
Roth IRAs are not subject to RMDs.
Are RMDs subject to taxes?
RMDs are subject to federal income taxes at ordinary income-tax rates. RMDs from Roth 401(k)s are not taxed as long as they meet the requirements for a qualified distribution including having met the five-year rule for Roth contributions.
Whether or not RMDs are subject to state income taxes will vary by state as some states do not tax distributions from retirement accounts.
What are the penalties for not taking RMDs?
The penalty for not taking some or all of your RMD is 50% of the amount not taken. You are still required to take the untaken amount as a distribution and all taxes must still be paid.
Ways to defer or avoid taxes on RMDs
There are several ways in which you can defer or avoid taxes on RMDs.
Qualified charitable distributions (QCDs) allow those who are at least age 70½ to divert up to $100,000 in distributions from a traditional IRA to a qualified charitable organization. There are no taxes on QCDs. They can be used to satisfy some of all of your RMD requirements as well, eliminating taxes on that portion of the RMD. Note that unlike normal charitable contributions, QCDs do not qualify for a charitable tax deduction.
Working longer can allow you to defer taking RMDs on any money in your current employer’s 401(k) if they have made the proper election as part of their plan documents. This deferral applies only to RMDs on this plan, RMDs on other accounts must still be taken. Once you are no longer employed by this employer, RMDs must be taken on this money as well. Note if the plan allows for it, you can consider a reverse rollover from an IRA into the plan to defer RMDs on that money as well.
Roth IRA conversions. RMDs will not be required from money converted to a Roth IRA. This is a way to eliminate future RMDs for some or all of the money in a traditional IRA. Note the amount of the conversion will be taxed in the year of the conversion. It is also important to note that RMDs for a given year must always be taken based on the RMD calculation prior to any Roth conversions that might be done during the year.
A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity that can be purchased inside of a qualified retirement plan or an IRA. Up to $145,000 can be used to purchase a QLAC and the annuity payments can be deferred out to age 85. During the deferral period, RMDs are not required on this money, they do resume once the annuity payments commence.
As you approach the age when RMDs must commence, be sure you understand how they work, what you are required to do and ways to defer or reduce RMDs that might be applicable to you. RMD planning is an important part of your retirement income planning.