MRD: It stands for machine-readable dictionary, Maine Roller Derby, and multicast routing debugger, among other things. However, most of us only need to know one of the terms this acronym stands for: the minimum required distribution. This is the amount of money you must withdraw from various retirement accounts once you reach a certain age in order to avoid steep IRS penalties. Read on to learn what the MRD is, why you need to know about it, and why you really don't want to break the MRD rules.
What it is
Many of us are dutifully saving money in retirement accounts, hoping they will sustain us in our golden years. Some of us plan to tap those accounts as soon as we hit our expected retirement age, while others would prefer to delay tapping them as long as possible so that they have more time to grow. Well, you may have a little less control over when you tap those funds than you thought you did.
When you invest through a Roth IRA, you can leave the money in the account to grow (tax-free!) over your entire lifetime, and no funds need to be withdrawn until you die. But with a traditional IRA or a 401(k) -- whether it's a traditional 401(k) or the newer Roth 401(k) -- you must start withdrawing money at age 70-1/2. And you can't simply withdraw some pocket change and call it good: The IRS requires you to withdraw at least your minimum required distribution (which is also referred to as a required minimum distribution -- but let's just go with "MRD").
Your MRD is calculated based on average life expectancies and the balance in your account as of the end of the previous year. The IRS provides helpful tables to help you determine what you need to take out, and many financial websites offer MRD calculators as well. In addition, your IRA custodian will likely inform you of your MRD while also reporting it to the IRS.
Why you need to know about it
If you don't know the rules regarding MRDs, it can be easy to make a mistake and wind up owing the IRS a lot of money. Here are some of the key rules you should know.
For every year in which you must take an MRD, it must be taken by Dec. 31 -- except for your first year. For the year in which you turn 70-1/2, you have until April 1 (not April 15) of the next year. In other words, if you turn 70-1/2 in 2015, you have until April 1, 2016 to make your first MRD. For the year 2016, you have until Dec. 31, 2016. Note that if you delay your first MRD until the next year, you'll be forced to take two distributions in the same year, which might boost your taxable income and bump you into a higher tax bracket. Proceed with caution -- and a calculator.
There are other rules to know, too, so do a little research to determine what's required in your specific situation. For example, with 401(k) plans, MRDs generally start when you turn 70-1/2 or when you retire, if that's later. And those who own 5% or more of the company sponsoring their retirement plan have special rules, too. Different retirement plans sometimes have particular rules about MRDs.
Your MRDs will usually be taxable as ordinary income for the year in which they're taken, and they may be subject to state or local taxes, too. As the IRS explains, "Your withdrawals will be included in your taxable income except for any part that was taxed before (your basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts)."
What if you break the rules?
So what happens if taking your MRD simply slips your mind, or you withdraw less than you needed to, or you make the withdrawal after the deadline? Well, you face a rather harsh punishment: You may have to pay an excise tax of 50% of the amount you failed to withdraw.
If you do mess up, you'll need to fill out IRS Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts," and include it with your federal tax return for the year in which you failed to take your MRD.
There's hope, however, for those who make honest mistakes. In the IRS' own words: "The penalty may be waived if the account owner establishes that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. In order to qualify for this relief, you must file Form 5329 and attach a letter of explanation."
Finally, remember to be strategic about your MRDs. If you have multiple IRAs, you have some choices to make. You must determine your MRD for each of them, but then you can withdraw the total of those MRDs from the three accounts in any way you see fit. For example, if you have three IRAs with respective MRDs of $2,000, $3,000, and $5,000 for a total of $10,000, you can withdraw that total from a single account or spread it out between the three accounts however you wish. In this situation, you should consider withdrawing from the IRA that's performing the worst or is generating the least in dividend and interest income.
Those with multiple 401(k) accounts must take the MRD from each account. In other words, you can't take the total required sum from whichever 401(k) you want, in whatever proportion you want. If your MRDs are $2,000 for one 401(k) and $1,500 for another, you must withdraw at least $2,000 from the former and at least $1,500 from the latter.
If your income is lower than usual in a given year, you might opt to withdraw more than the MRD in your accounts. And if you expect your income to rise in the coming years and push you into a higher tax bracket, it may be worth taking more than the MRD while you're still in a lower bracket.
Knowing the rules regarding MRDs can help you save money and make the most of your retirement investments.