If you’re turning 72 years old and have assets in a traditional IRA, 401(k), or 403(b), you’re subject to required minimum distributions (RMDs). Here are some things to know.
Are you in (or close to) your early 70s ? Do you have any tax-deferred retirement accounts, such as a traditional IRA, 401(k), 403(b), profit-sharing, SEP IRA, SIMPLE IRA, or other defined-contribution plan?
If so, you need to get familiar with three letters: RMD. What is RMD, you ask? It’s short for required minimum distribution—an amount the government requires you to take from your tax-deferred accounts each year once you reach a specific age—72 for anyone born after June 30, 1949.* More importantly, as you take each distribution, you’re essentially declaring it as income, which means it’s time to pay taxes on it.
Why the asterisk regarding age 72? That’s due to the SECURE Act of 2019—more on that in a bit.
Here are a few things to consider as you plan for those required minimum distributions.
It’s required. According to RMD rules, failure to take one can be costly, as the IRS will assess a penalty in the amount of 50% of the difference between your RMD and what you actually withdrew from your tax-deferred accounts. For example, if you have an IRA with a required minimum distribution for the current year of $12,000 and you only take, say, $5,000, you’d be assessed a penalty of half the $7,000 difference, or $3,500. Yowza!
After decades of diligent saving, all while allowing your nest egg to grow with no taxes assessed along the way, it’d be a shame to take such a massive hit. So it’s important to pay attention to the RMD rules.
It’s a minimum amount. Why does the IRS care if you take a minimum amount each year? In a word: taxes. Tax deferral can be a generous incentive, one that was put in place to encourage people to save for retirement. Once you reach retirement age, it’s mission accomplished, which means, as far as the IRS is concerned, it’s time to pay taxes on at least a minimum amount each year.
When you turn 59.5, you can begin taking distributions and paying taxes on them, but doing so isn’t mandatory until age 72.* If you continue working, or if you simply have no need for the money, there’s probably no reason to start taking distributions early. In fact, when you’re working, you might still be contributing to a plan. But once you turn 72* you can defer no longer.
One side note: If you’ve made nondeductible contributions to an IRA over the years, those might not be taxable, but they’ll still be figured into the RMD calculation (more on nondeductible contributions below).
It’s a distribution, and here’s what you need to know.
RMDs will vary from person to person and account to account and are based on two factors:
To figure the RMD amount for any applicable retirement account, you divide the account balance by the distribution period, as shown in one of three tables provided by the IRS (worksheets and tables are available on the IRS website). Most likely, though, you won’t be required to do the math; typically the custodian of each of your eligible accounts—a broker, bank, or plan sponsor, for example—will calculate the RMD for you each year.
The SECURE Act, signed into law in December 2019, brought a few changes to the retirement system—and perhaps to your retirement planning.
One biggie was the change in the RMD age from 70.5 to 72 for anyone born on or after July 1, 1949. But if you’re already over 70.5 and taking RMDs (or are required to), you’ll need to continue taking them.
Learn more about the SECURE Act and how it could affect your retirement. Or visit the TD Ameritrade retirement page for help.
According to RMD rules, the first distribution is due the year you turn 72, but you can postpone it until April 1 of the following year. After that first year, the annual deadline is December 31. Although you can delay that first RMD into the next calendar year, that means you’ll be taking two in that second year: one by April 1; the other by the end of the year.
But here’s an R you can ignore (somewhat) when considering RMDs: Roth. If you have a Roth IRA, no RMD is required. Unlike a traditional IRA, where taxes are deferred until funds are withdrawn, a Roth IRA is taxed up front and is tax free when you take it as a distribution. However, this is only true during the owner’s lifetime. Afterward, a Roth IRA is subject to RMDs, and the same 50% penalty will apply unless a surviving spouse is the sole beneficiary. A surviving spouse who inherits a Roth IRA can become the new account owner (by rollover) and wouldn’t be subject to RMDs during his or her lifetime.
Also, although Roth IRAs don’t require minimum distributions, Roth 401(k) plans do, so you can’t ignore Roth 401(k) accounts. If you have money in a Roth 401(k), and you wish to sidestep the RMD, you might consider rolling the 401(k) into a Roth IRA.
Here are a few more facts and considerations about RMDs:
These rules can get tricky, so if you’re at all in doubt, consult a tax professional for more information.
Required minimum distributions shouldn’t be considered a government tax grab but rather a fact of retirement investing. If you’ve saved and invested diligently over the years, you’ve likely gotten the better end of the deal tax-wise, as your investments hopefully grew without taxes being assessed along the way.
You don’t have to liquidate holdings to take the RMDs, but rather, you can transfer securities into a taxable account if you wish. Just know that you’ll need to pay taxes on their value at the time of transfer. Plus, you might be required to pay transfer fees. Some investors choose to liquidate enough securities to cover the tax bill, then transfer an amount equivalent to the RMD into a taxable account.
And remember, if your budget allows it, you could use the RMD as additional “fun money.” After all, isn’t that what retirement is all about?
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
TD Ameritrade does not provided tax advice, please consult your tax advisor.
An investor should consider a 529 Plan’s investment objectives, risks, charges and expenses before investing. The Program Disclosure Statement, which contains more information, should be read carefully before investing.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2024 Charles Schwab & Co. Inc. All rights reserved.