Unless you saved for retirement exclusively in Roth accounts, some of your retirement money has an IRS claim on it, and there are laws in place to ensure it gets its cut. One of the lesser-known rules involves required minimum distributions (RMDs), something that about 3 in 10 retirees are completely unprepared for, according to a recent survey by Principal.

Unfortunately, the government isn't going to accept "I didn't know I had to take RMDs" as an answer. So you need to know how they work and when to take them if you want to avoid penalties. Here's a primer to get you started.

Worried senior couple looking at financial documents

Image source: Getty Images.

What are RMDs?

RMDs are mandatory amounts you must withdraw from all of your retirement accounts annually, except Roth IRAs. Because you've already paid taxes on your Roth IRA contributions, you don't owe taxes on your withdrawals in retirement, so the government leaves these alone.

Oddly, Roth 401(k) funds are subject to RMDs, though they're also funded with after-tax dollars. But you can avoid the RMD requirement for these accounts by rolling your savings over into a Roth IRA. Doing this won't affect your tax bill because they're both Roth accounts, though you may pay a one-time rollover fee.

Failing to take RMDs when you're supposed to results in a 50% penalty on the amount you should have withdrawn. That's higher than the highest income tax bracket, so it's never worth it. You're better off budgeting for RMDs annually and paying taxes on them at your ordinary income tax rate. You may also withdraw more than your RMD in a given year if you want, and there's no penalty for doing so. 

When do I have to take RMDs?

You must start taking RMDs beginning at 70 1/2 if you were born on June 30, 1949, or earlier. Those born after this date don't have to start RMDs until 72. There is an exception to these starting ages for adults who are still working at the time.

If you were supposed to start RMDs when you turned 70 1/2, but you're still employed and you own less than 5% of the company you work for, you can delay RMDs from your workplace retirement account until you finally quit your job. But this does not excuse you from taking RMDs from any other retirement accounts in your name. You can roll these accounts into your workplace retirement account if the plan permits it to avoid RMDs. Otherwise, you may just have to begin withdrawing funds from these accounts and paying taxes on them even if you're not ready to spend them yet.

The federal government waived the RMD requirement for 2020 in response to the COVID-19 pandemic, but so far, it's looking like seniors will still have to take their RMDs in 2021. It's possible the government could suspend RMDs for 2021 as well if it feels it's necessary, but for now, it's best to plan as if you'll need to take them.

How much do I need to withdraw from my retirement account each year?

You calculate your RMDs for each retirement account by dividing the account balance on Dec. 31 of the preceding year by the distribution period next to your age in this table. For example, if you're turning 72 in 2021 and you had $100,000 in a traditional IRA on Dec. 31, 2020, your RMD would be about $3,906 ($100,000 divided by the 25.6 distribution period for 72-year-olds).

That's the minimum you must take out in 2021 from that account if you hope to avoid penalties. If you have other retirement accounts as well, you'd repeat the same steps using each account's retirement balance to figure out how much you must withdraw from each one. You may take these withdrawals all at once or spread them out over the year as you see fit.

How do I plan for RMDs?

You probably can't say for sure how much you'll need to withdraw annually from your retirement accounts if you don't have to take RMDs yet. It depends on how much you withdraw from your accounts before you have to begin RMDs and how your investments perform over time. But you should be able to approximate what your RMDs might be, based on what your balance is now and how much you expect to withdraw each year in retirement.

RMDs might not be an issue if you'd already planned to withdraw more than this amount to cover your living expenses. But if your RMDs are higher than you expected, you should prepare for a larger tax bill. You may be able to counter this by reducing your spending slightly to keep yourself from jumping up a tax bracket, but that might not be possible in every case. At the very least, understanding what your RMDs are and being sure to take them before the end of the year can help you avoid costly penalties.

Taking RMDs doesn't mean you have to spend all that money right away. You can hold some of it to help cover your tax bill or place it in a high-yield savings account or even a taxable brokerage account if you're not ready to use it yet. Weighing all these choices every year can help you make a decision that makes the government happy and enables you to keep as much of your savings as possible.