You’ve invested diligently for years and are now close to the day when you can finally withdraw from your retirement account. The last thing you want is a penalty for overdrawing from your account and paying taxes on your hard-earned gains. 

While most investors are aware of penalties for withdrawing from their IRA early, you can also be penalized if you don’t withdraw the appropriate amount of money from your retirement account each year. 

Knowing how to calculate your required minimum distribution can help you avoid unnecessary penalties that could diminish your investment.  

What Is the Required Minimum Distribution?

A required minimum distribution(RMD) is a minimum withdrawal you must make from your traditional IRA, SEP-IRA, SIMPLE IRA, self-directed IRA, or other qualifying retirement plans once you reach a specific age.  RMD requirements are set by the Internal Revenue Service (IRS) and are based on the age of retirement account holders. 

Currently, any individual who is 70 years of age by July 1, 2019, is required to start taking their RMD at the age of 72. However, before 2019 and the Setting Every Community Up for Retirement Enhancement (SECURE) Act, account holders were required to take their annual RMD at the age of 70 ½. 

RMDs are considered taxable income and withdrawals should be included during the appropriate tax year. However, if your retirement funds were already taxed, as for Roth IRA funds, withdrawals are not included as part of your annual taxable income.  

How to Calculate Required Minimum Distribution?

There are typically two ways you can calculate your RMD, and the method you choose depends on whether you or your spouse is the primary beneficiary. 

If you’re the primary beneficiary on your retirement account, you can determine your RMD by dividing the prior year’s balance by the IRS-determined life expectancy factor.  Life expectancy factors can be found in the IRS Uniform Lifetime Table.

Account Balance (as of December 31 of the prior year) / Life Expectancy Factor = RMD

For instance, if you are 73 years old, your life expectancy factor (a.k.a distribution period) is 24.7. Therefore, if your account balance as of December 31 is $200,000, your RMD would be $8,097. 

If you have more than one qualifying retirement account, you should calculate the RMD for each account and plan to make the appropriate withdrawal. 

The IRS allows individuals with multiple IRA accounts or multiple 403(b) tax-sheltered annuity accounts to take the total withdrawal from a single account instead of withdrawing from each account. However, if you have multiple defined contribution plans, like two 401(k)s, you’ll need to withdraw a separate amount from each account. 

In addition, if your spouse is the sole beneficiary and is 10 or more years younger than you, then your life expectancy factor can be determined by looking at the IRS Joint Life Expectancy Table. Otherwise, you can use the life expectancy factor established in the IRS Uniform Lifetime Table. 

The government sets annual minimum distribution thresholds, and the rules regarding RMDs can change. As such, it’s a good idea to check with the most recent IRS information available to determine how much you’ll need to take out and when. 

Additionally, speaking with a financial expert, such as your SDIRA custodian, can help you determine if you’re calculating your RMD correctly and ensure you avoid unnecessary penalties. 

RMD FAQs

What happens if I don’t withdraw my RMD by the deadline?

If you don’t withdraw your annual RMD, or if your withdrawal doesn’t meet the minimum required, the RMD amount that remains in your investment account will be taxed at 50%. To avoid unnecessary taxation, it’s important to calculate your RMD correctly and be aware of IRS RMD deadlines. 

Currently, qualifying retirement account holders must take their initial distribution by April 1, and all subsequent distributions must be made by Dec 31. During the first qualifying year, account holders typically must make an initial withdrawal by April 1 of that year and another by December 31 of that same year. 

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What retirement plans have an RMD?

If you have any of the following retirement accounts, you’ll need to plan for an annual RMD that meets IRS requirements:

• Traditional IRA
• SEP
• SIMPLE IRA
• SARSEPs
• 401(k) plans
• Roth 401(k) plans
• 403(k) plans
• 457(b) plans
• Profit-sharing plans

How do I avoid the required minimum distribution?

In most cases, you can avoid RMDs by converting your retirement plan to a Roth IRA, essentially rolling your existing retirement balance into a tax-free retirement account. However, that does mean you’ll avoid taxes altogether.  If you choose this method, you’ll need to pay taxes on the funds going into the new Roth IRA. 

If your retirement account is employer-based, like a 401(k), then you can put off paying RMDs by working longer. That’s not an option for IRA account holders, however. 

Is it better to take RMD monthly or annually?

Like other financial decisions, there’s no one-size-fits-all approach to how you schedule your RMD.  The best way to determine what schedule you should follow is to evaluate your needs.  

Do you plan on using your RMD as a source of regular income? If so, monthly withdrawals will likely work best.  

If you plan on using your RMD for other purposes, like taxes, charitable giving, or reinvestment, an annual schedule may be more appealing.  If you’re not sure, consult a financial expert who can help you determine the best course of action. 

Can I reinvest my RMD?

Yes, you can reinvest your RMD, but the funds cannot be deposited into a tax-advantaged retirement account. Taxable brokerage accounts are a popular option for individuals looking to reinvest, but speak to a financial expert to determine what investment options are best for you. 

Can I take out more than my RMD? 

Yes, you can take out more than your required minimum distribution. However, as long as you meet your required RMD, you’re not penalized for additional funds to cover living expenses, investment goals, charitable contributions, etc. 

Following IRS guidelines and taking out the appropriate annual distribution will help you avoid unnecessary penalties and make the most of your retirement funds. 

Ultimately, by understanding the rules governing your IRA’s RMD, you can avoid taxes on your withdrawals and protect your wealth.

If you’re concerned about or unsure of your distribution obligations, or if you want to learn more about how you can reinvest your funds, contact Horizon Trust today. We can help you understand your obligations and identify investment options that fit your goals.