RMD stands for required minimum distribution, which is the amount of money that you must withdraw from certain tax-deferred retirement accounts each year once you reach a certain age. RMDs apply to original account holders and their beneficiaries in these types of plans:
- traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401 (k) plans
- 403 (b) plans
- 457 (b) plans
- Roth IRA beneficiaries
The purpose of RMDs is to ensure that you pay taxes on the money that you saved in these accounts, since you did not pay taxes when you contributed to them. RMDs also prevent you from accumulating tax-deferred savings indefinitely.
The amount of your RMD depends on your account balance and your life expectancy, as determined by the IRS. You can use the IRS tables to calculate your RMD, or use an online RMD calculator. The formula is:
RMD = Account balance / Distribution period
The account balance is the value of your account as of December 31 of the previous year. The distribution period is the number of years you are expected to live, based on your age and the IRS tables.
The deadline for taking your first RMD is April 1 of the year following the calendar year in which you reach age 73. For subsequent years, you must take your RMD by December 31. If you delay taking your first RMD until the year after 73, then you will have to take two RMDs in the same year, which may increase your tax liability so it might make more sense to take your first RMD in the year you turn 73.
Example:
Bob turns 73 in 2024 and his RMD is $45,000. The deadline to take his first RMD is April 1st of 2025, but he would also need to take another RMD in 2025. So there would be 2 RMD totaling $90,000 in 2025 which will increase taxes. Bob could have taken the first RMD in 2024 instead of waiting until 2025, that way he can report the RMD in separate years and pay lower taxes.
There are some exceptions to the RMD rules. For example, if you are still working and participate in your employer’s 401 (k) plan, you can defer taking RMDs from that plan until you retire, unless you own 5% or more of the company. Roth IRAs do not require RMDs for the original owner, but beneficiaries of Roth IRAs must follow the RMD rules. If you inherit an IRA or a retirement plan account, the RMD rules depend on your relationship to the original owner and the type of account.
If you fail to take your RMD, or take less than the required amount, you will face a 25% penalty on the amount that you did not withdraw. You may be able to avoid the penalty if you can show that you had a reasonable cause for missing the deadline, and that you took steps to correct the mistake as soon as possible.
RMDs are an important part of retirement planning, as they affect your income, taxes, and estate planning. You should contact us here at Moontree Tax Service to help you understand and comply with the RMD rules, and to optimize your withdrawal strategy.
