If you have tax-deferred retirement accounts, there comes a point when you have to start withdrawing your money, even if you don't need it – a concept known as MRD, or minimum required distributions. Here's what you need to know about whether you need to take a MRD, how much to withdraw, and some mistakes to avoid.
What is a MRD?
When referring to a retirement account, MRD stands for minimum required distributions, which are mandatory withdrawals you must take from certain retirement accounts after you reach age 70 1/2. It's also important to note that you may also see the term written as RMD, or required minimum distribution -- both refer to the same thing.
Basically, MRD requirements apply to any accounts that you contributed to on a pre-tax basis, or that contain tax-deferred investment gains. This includes, but is not limited to:
- 401(k) accounts (except Roth 401(k)s).
- 403(b) accounts.
- Keogh accounts.
- Traditional IRAs.
- SEP-IRA accounts.
- SIMPLE IRA accounts.
When do you need to take your first MRD?
As the rule is written, you need to take your first MRD from your tax-deferred retirement accounts by April 1of the year following the calendar year in which you turn 70 1/2. For example, if you turn 70 1/2 on in January 2016, you'll have until April 1, 2017, before you'll be required to take your first MRD.
In subsequent years, you need to take your annual MRD before Dec. 31. And bear in mind that you don't need to take a lump-sum withdrawal. You can spread your withdrawals out throughout the year as long as you withdraw the required amount before the deadline. If you calculate your MRD requirement for a certain year to be $50,000, you can withdraw $4,167 per month, $961 per week, or any other distribution schedule you'd like.
Two warnings about MRDs
While the rules permit you to wait until April 1 of the year following your 70 1/2 birthday to take your first MRD, that doesn't necessarily mean it's a good idea to do so.
To explain why, consider the following example. Let's say that you turn 70 1/2 this year (2015) and that you calculate your first MRD to be $50,000, which you decide to wait until the last minute to take, so April 1, 2016. Well, because you waited until the next calendar year, you'll have to take another MRD by Dec. 31 in to meet your 2016 MRD requirements. Assuming you'll have to withdraw another $50,000, this will leave you with $100,000 of taxable income for 2016, which is likely to catapult you into a higher tax bracket.
Just to put this in perspective, $50,000 in taxable income translates to $8,294 in federal tax liability, while $100,000 boosts this amount dramatically to $21,071. So, even though you're allowed to wait, it generally is a better idea to take your first MRD in the calendar year you turn 70 1/2.
The second warning is more straightforward: If you fail to take your MRD, the penalty is extremely harsh. The IRS can penalize you 50% of the amount of the MRD not taken by the deadline. So, if you're supposed to withdraw $50,000 and do nothing, the IRS can take a whopping $25,000 penalty from your retirement nest egg. Under no circumstances should you ever withdraw less than your MRD amount.
How to calculate your MRD requirement
Your MRD requirement depends on the balance of your retirement accounts, as well as your age and the age of your spouse. Using tables provided by the IRS, you can find your life expectancy factor. You then divide your account balance by this factor in order to determine your MRD each year.
If your spouse is younger than you by 10 or more years and is the sole beneficiary of your retirement accounts, use the IRS's Joint Life and Last Survivor Expectancy Table, which results in a lower MRD requirement. Otherwise, use the Uniform Lifetime Table.
For example, let's say you have $1 million in a 401(k) and need to calculate your first MRD (you're 70) and your spouse is 65 years old. According to the Uniform Lifetime Table, your distribution period is 27.4, which tells you that your first MRD should be $36,496. On the other hand, if your spouse is 50, the life expectancy factor changes to 35.1 and you're only required to withdraw $28,490.
Can you avoid MRDs?
Not really. If you have a tax-deferred account like the ones mentioned earlier, you generally can't get around your MRD requirement if you're over 70-1/2. However, there are two ways to potentially avoid MRDs.
- Start contributing to a Roth IRA, or convert your existing accounts to Roth accounts. You'll end up taking a tax hit since Roth contributions are made on an after-tax basis, but Roth accounts have no MRD requirements.
- If you're still working, you might be able to avoid taking MRDs until you retire, but only on employer-sponsored retirement plans such as 401(k), 403(b), and Keogh accounts.
To sum it up
If you are fortunate enough to not need the money in your retirement accounts when you reach age 70 1/2, MRDs can seem like an inconvenience. However, keep in mind that the penalty for not taking your required distributions is severe, so it's important to withdraw the required amount, even if you don't want to. And if you're still several years from retirement, you can start planning for MRDs now by putting money into a Roth IRA.