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Required Minimum Distribution (RMD): How Does It Work?

Retirement Planning
happy retired couple uses required minimum distribution from their ira to take a fun road trip

If you've been saving for your retirement and are turning 70 relatively soon — or even if you're simply revisiting your retirement savings plans — there's an important acronym you may want to know about: RMD. That stands for required minimum distribution.

In a nutshell, when you turn 70 1/2, there is a minimum amount of money you'll need to withdraw each year (as a "distribution") from your Individual Retirement Accounts (IRAs) and retirement plan accounts from work. (This doesn't apply to Roth accounts, however.) If you don't take that RMD, the IRS will take a 50 percent tax on the amount you should have withdrawn.

Even if you don't need the money to cover your living expenses, you still need to take that required minimum distribution. You're not required to spend the withdrawal after taxes, however, so you can keep what remains for future use or to pass on to your heirs. Essentially, the IRS wants to start collecting income tax on your retirement savings when you reach a certain age. The resulting tax revenue is worth more to the IRS today than years into the future.

If you're still working at age 70 1/2 and have money in an employer-sponsored retirement plan, you're allowed a bit of a reprieve. While you still need to take an RMD from your IRAs, you do not have to start taking funds out of your employer-sponsored plan until you retire. If you own more than five percent of the company you work for — as can be the case with small business owners — you're excluded from this postponement opportunity.

How Do You Calculate Your RMD?

The IRS offers a table to simplify your RMD calculation, which you can use unless you have a spouse who's more than 10 years younger than you. The table, which is based on average life expectancy, gives you a distribution period number that corresponds to your age.

Your RMD is your retirement savings divided by the distribution period. For example, the table shows the distribution period for a 72-year-old is 25.6. So if you had $500,000 in your retirement accounts on Dec. 31, 2017, your RMD would be $19,531. You would need to take that amount out of your retirement accounts by the end of 2018 and add it to your taxable income for the year.

Remember that for your first RMD, you don't need to take that distribution until April 1st of the following year. In that case, however, you would have to withdraw twice during the following year, as the age 71 distribution would also be due.

The older you are, the smaller your distribution period number is because that number is based on how many years — on average — someone of your age will live. The idea is that you should draw down your retirement accounts by the time you pass away. But the number never goes to 1 (i.e., 100% of the account balance). Even if you live to 100, the distribution period is 6.3, meaning you'd need to take out about one-sixth of your account balance that year.

RMDs for Multiple Retirement Accounts

To calculate your RMD when you have multiple accounts, you can combine the assets in similar types of accounts, but take the distribution from only one of those accounts. Suppose you have a combined total of $250,000 in two separate IRAs, and another $250,000 in two separate 401(k) accounts. If you're 72, as in the earlier example, your distribution period is still 25.6. That means you'd need to take RMDs totaling $9,766 from your IRAs and $9,766 from your 401(k) accounts. You could take the entire $9,766 IRA amount from one IRA, or divide it between the two. The same applies to your 401(k)s.

Having to take a required minimum distribution can be a good kind of "problem" to have — especially if that RMD is large — as it generally indicates you have retirement savings built up. And since you can do what you want with your distribution, you could always keep it in another savings account or channel it toward enriching your life in retirement in whatever way you'd like.

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Information provided is general and educational in nature, and all products or services discussed may not be provided by Western & Southern Financial Group or its member companies (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. Consult an attorney or tax advisor regarding your specific legal or tax situation.