Tax-deferred retirement saving is one of the best tools at investors' disposal, but you can't simply let your money grow forever -- at some point, you have to start withdrawing it. This is known as required minimum distributions (RMDs), which is an IRS rule that says you need to start taking distributions from certain retirement accounts beginning at age 70 1/2.
Here's a guide to what an RMD is, when your RMD deadline is, and how to calculate your 2018 RMD. Be sure that you get this right. The penalty for non-compliance is severe.
What is an RMD?
RMD stands for required minimum distribution, and is an annual minimum amount that must be withdrawn from certain types of retirement accounts after you reach 70 1/2 years of age.
Generally speaking, you have to take each year's RMD by the end of the calendar year. The only exception is for your first RMD, which must be taken by April 1 following the calendar year during which you turn 70 1/2. For example, if you turn 70 1/2 during 2018, you technically have until April 1, 2019, to take your first RMD. (I say "technically" because there's a good reason not to wait until the last minute, which we'll get into later on.)
You can choose to take your RMD however you want. You can take a series of payments throughout the year, or you can take your RMD in a lump sum. And if you have more than one account subject to RMD rules, you can choose to withdraw your total RMD from just one account, or from a combination of them, as long as the overall minimum amount is withdrawn during the year.
What accounts have RMD requirements?
All retirement accounts where contributions are made on a pre-tax basis are subject to RMD requirements. This includes, but is not necessarily limited to:
- Traditional IRAs
- 401(k)s, 403(b)s, and 457s (although if you're still working for the sponsoring employer, you may be exempt from the RMD requirement)
- SIMPLE IRAs
What's exempt from RMDs? After-tax retirement accounts -- specifically Roth IRAs and any portions of 401(k) or similar accounts that came from Roth contributions don't have RMD requirements. The primary reason RMD rules exist is to ensure that you eventually pay your taxes on the funds in your account. Qualified Roth withdrawals are tax-free, so the IRS doesn't really care how long you leave your money in the account.
How to calculate your 2018 RMD
To calculate your 2018 RMD, you'll need the following information:
- Your account balance(s) as of Dec. 31, 2017.
- The age you'll reach in 2018.
- The appropriate life expectancy table from the IRS. For most people, this is the Uniform Lifetime Table. If your spouse is the sole beneficiary of your account and he or she is over 10 years younger than you, you'll use the Joint Life and Last Survivor Expectancy Table, which you can find in IRS Publication 590-B.
Once you have this information, the calculation is fairly simple. By dividing your account balance(s) by the appropriate life expectancy factor in the IRS table that applies to you, you can calculate your 2018 RMD.
For example, let's say that you have $500,000 in various tax-deferred retirement accounts, and that you're turning 75 in 2018. According to the Uniform Lifetime Table, your life expectancy factor is 22.9. Dividing $500,000 by 22.9 gives a 2018 RMD of $21,834.
If you turn 70 1/2 in 2018, be careful about waiting
As a word of caution, keep in mind that withdrawals from retirement accounts that have RMD requirements are considered taxable income.
Here's where this can get you into trouble. Let's say that you'll turn 70 1/2 in 2018. This means that you have until April 1, 2019 to take your first RMD. However, your second RMD will also be due by the end of 2019. By waiting until 2019 to take your first RMD, you'll have two big withdrawals in the same calendar year, which could easily bump you into a higher tax bracket.
The point: If you turn 70 1/2 during 2018, it can be a smart tax move to take your first RMD by the end of the year, even though you aren't required to do so.
The penalty for non-compliance is severe
Finally, under no circumstances should you ignore the RMD rules. The penalty for failing to take a RMD is one of the harshest penalties assessed by the IRS -- 50% of the amount you were supposed to withdraw. For example, if your 2018 RMD is $30,000 and you don't withdraw anything, you will be penalized $15,000.
Don't give your retirement savings away to the IRS. Double-check that you withdraw enough from your accounts by the deadline.