If you imagined spending your retirement like Smaug the dragon, sitting atop a pile of gold (by which we mean retirement savings), think again. The IRS wants you to start taking money out of your retirement accounts beginning around age 70.5. This money goes by the name required minimum distributions (RMDs). Want to learn more? You’re in the right place.
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The following kinds of retirement accounts all come with required minimum distributions:
- SIMPLE IRAs
- Traditional IRAs
- Profit-sharing plans
- Other defined contribution plans
For IRAs, SEP-IRAs and SIMPLE IRAs, the date for beginning required minimum distributions is April 1 of the year following the calendar year in which you turn 70.5. For 401(k)s, profit-sharing agreements, 403(b)s and other defined contribution plans, the beginning date for RMDs is usually April 1 after the later of either a) the year you turn 70.5 or b) the year you retire.
Why Are There Required Minimum Distributions?
You may be wondering why the IRS doesn’t let you wait as long as you want to take distributions. Here’s why: The above account types all offer tax-deferment. With these accounts you can make tax-deductible contributions and enjoy tax-deferred growth. From the time you first open, say, a traditional IRA, to the time you turn 70.5, the IRS is getting nothing out of your IRA savings.
You didn’t expect the Tax Man to defer your taxes indefinitely, did you? That’s why the IRS imposes required minimum distributions. Without RMDs, people could use tax-deferred retirement accounts to stash their money indefinitely and never pay taxes on the funds. In exchange for letting you deduct your contributions to tax-deferred accounts, the IRS wants to make sure that it gets its share when you’re in your golden years.
Why Don’t Roth IRAs Have RMDs?
Because Roth IRAs (and Roth 401(k)s) are funded with after-tax dollars, the IRS has already gotten a cut. Roth accounts are great because you don’t pay taxes on the money you take out of them in retirement, and you’re not required to dip into them if you don’t need to. Some strategic folks choose to diversify their tax burden in retirement by having a mix of Roth and non-Roth accounts.
How Are Required Minimum Distributions Calculated?
Great question. To calculate this year’s RMD, take the account balance at the end of the previous calendar year and divide it by the distribution period you find on the IRS’s Uniform Life Table. The “distribution period” is pretty much a nice way of saying, “the number of years you have left.”
Of course, because it’s the IRS, there are exceptions that complicate things. If someone is the sole beneficiary of a deceased’s retirement account, and that someone is the spouse of the deceased, and that spouse is 10+ years younger than the deceased, a separate life expectancy table is used to calculate RMDs. This is called the Joint Life and Last Survivor Expectancy Table. Other beneficiaries who need to calculate RMDs use the Single Life Table.
Do Inherited Accounts Have RMDs?
Yup. If you inherit one of the retirement accounts listed above (or even a Roth IRA), you will have to take RMDs. The rules on these distributions depend on whether you’re the spouse of the deceased or another, non-spouse beneficiary.
If you’re the spouse and sole beneficiary of the retirement account, you have several options. You can treat the inherited retirement account as yours and roll it over into a retirement account of your own, base RMDs on your age, base RMDs on your late spouse’s age at death and reduce the distribution period by 1 year annually or withdraw the entire amount by the end of the fifth year after retirement, provided your spouse died before the age at which he/she should have taken RMDs. If your spouse died before reaching the age for RMDs, you can wait until he or she would have reached age 70.5 to start taking distributions.
The rules for beneficiaries who aren’t spouses are different. If the account owner died before the beginning date for RMDs, you can pocket the entire account balance by the end of the fifth year after the account owner’s death. Alternatively, you can calculate required minimum distributions based on the Single Life Expectancy Table.
Do required minimum distributions sound too complicated? Are you considering taking your chances, skipping the RMDs and hoping the IRS doesn’t notice? Not a good idea. If you skip taking distributions, or if you take distributions that are too small, you’ll pay for it. To be specific, you will owe the IRS a 50% excise tax on the sum you should have taken in distributions. This applies to beneficiaries as well, so add “start taking RMDs” to the list of things you have to do when you inherit.
If you’re overwhelmed, consider talking to a finacial advisor. A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three registered investment advisors who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you.
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