RMDs (Required Minimum Distributions): What They Are and How They Work

Max
Apr 14
2 min read

Once you reach a certain age, the IRS requires you to start withdrawing a minimum amount from tax-deferred retirement accounts each year. These Required Minimum Distributions (RMDs) help ensure that retirement funds are eventually taxed. Understanding RMDs can help you plan your withdrawals wisely and avoid penalties.

1. What Are RMDs?

RMDs are mandatory withdrawals from traditional IRAs, 401(k)s, 403(b)s, and other tax-deferred retirement accounts. These withdrawals are taxable as ordinary income and must be taken annually once you reach the required age.

2. When Do RMDs Start?

If you turn 73 in 2024 or later, RMDs must begin by April 1 of the year after you turn 73.
For those who turned 72 before 2023, RMDs were required to start earlier.
Roth IRAs do not require RMDs during the owner’s lifetime.

3. How Are RMDs Calculated?

RMDs are determined using an IRS formula based on:

Account Balance: The total balance of your tax-deferred accounts as of December 31 of the previous year.
Life Expectancy Factor: The IRS publishes life expectancy tables to determine the required withdrawal amount.
Example Calculation: If you have $500,000 in an IRA and your life expectancy factor is 25.6, your RMD would be $500,000 ÷ 25.6 = $19,531 for the year.

4. How Are RMDs Taxed?

RMDs are taxed as ordinary income in the year they are withdrawn.
They may increase your taxable income, potentially affecting Social Security taxation and Medicare premiums.

5. What Happens If You Don’t Take an RMD?

Missing an RMD results in a hefty penalty—25% of the required amount (reduced to 10% if corrected within two years).
To avoid penalties, ensure you withdraw at least the required amount each year.

6. Strategies to Manage RMDs Efficiently

Start Early Withdrawals: Taking smaller withdrawals before age 73 can spread out taxable income.
Roth Conversions: Converting part of a traditional IRA to a Roth IRA before RMDs start can reduce future required withdrawals.
Qualified Charitable Distributions (QCDs): Donating up to $100,000 from an IRA directly to charity can satisfy RMDs tax-free.
Use RMDs for Expenses: Consider using RMDs to pay for healthcare costs, long-term care, or reinvestment in taxable brokerage accounts.

7. Can You Delay RMDs?

If you continue working past 73 and have a 401(k) with your employer, you may be able to delay RMDs from that specific plan until you retire.
Roth IRAs do not require RMDs, making them a useful tax-planning tool.

Final Thoughts

RMDs are an important part of retirement planning, and understanding how they work can help you avoid penalties and manage your tax burden. By planning ahead, exploring Roth conversions, and considering charitable giving, you can make the most of your retirement savings. Consulting a financial professional can help you develop a tax-efficient RMD strategy tailored to your needs.