Required Minimum Distribution (RMD): What is it?

When you reach age 72 (previously 70 1/2), the IRS requires you to start withdrawing from your tax-deferred investment accounts such as traditional IRAs (which Acorns offers), SEP IRAs and 401(k) plans on an annual basis. These withdrawals are known as required minimum distributions or RMD. 

The amount you take as an RMD each year is determined by IRS rules. And if you don’t take it when it’s required, you’ll have to pay a steep penalty. 

Why does the IRS require these distributions?

The IRS has allowed you to defer paying taxes on all the income you’ve socked away into your tax-advantaged retirement accounts over the years. But eventually, the IRS expects to collect those taxes. It ensures that it can collect by requiring you to start taking distributions at age 72. 

If the IRS didn’t require you to take distributions, you could conceivably live off other income and never cash out the funds in your IRA or 401(k). Then you could leave the accounts to your children as an inheritance, and the IRS would never get the tax dollars from the original income you invested. The RMD is its way of ensuring that you’ll eventually pay up on those tax-deferred investments.

Keep in mind, if you have a Roth IRA, you paid tax on the funds before contributing them. So there is no required distribution from your Roth IRA. You can leave funds there as long as you like.

How much am I required to withdraw? 

You can determine the distribution amount you’re required to take each year by looking at the IRS’s Uniform Lifetime Table. This table offers a “distribution period” figure that corresponds with each age from 70 to 115 and older. Each year, you divide your IRA (or 401k) account balance by the distribution period figure corresponding with your age. The quotient is the amount you are required to withdraw for that year. 

For instance, say you have a traditional IRA with a balance of $100,000 and you are 72 years old. The distribution period figure corresponding with age 72 is 25.6, so you would divide 100,000 by 25.6 with a result of $3,906.25. By April 1 of the year after your 72nd birthday, you would be required to withdraw $3,906.25 from that IRA. If you have several IRAs, you must take RMDs from each one on an annual basis.

If you haven’t retired by the time you reach age 72, you can delay taking RMDs until you retire. In that case, you must start taking RMDs by April 1 of the year after you retire. But this only applies to the first RMD. According to the IRS, for each subsequent year after your required beginning date, you must withdraw your RMD by Dec. 31. In this case, it’s possible that an investor will have to take two RMDs in the first year.

Can I withdraw more than the RMD? 

Yes, you can withdraw any amount you want from your IRA, 401(k) or other retirement account. After you’ve reached retirement age, you can make withdrawals without penalty. You will just be required to pay taxes on your withdrawals at your regular income tax rate. 

However, if your goal is to ensure that your savings will last throughout your retirement, it’s wise to develop a strategy for withdrawals that will avoid the possibility of running out of money.

How have the RMD rules changed? 

The rules related to RMDs changed on Jan. 1, 2020 when the Secure Act went into effect. Previously, RMDs were mandatory when a person reached age 70 ½. Starting in 2020, RMDs are mandatory once a person reaches age 72. When you turn 72, you must take your first RMD by April 1 of the following year. 

Also beginning in 2020, taxpayers may continue contributing to their traditional IRAs beyond age 70 ½, as long as they have earned income. In the past, no contributions were allowed after the account owner reached the age of 70 ½. 

If you inherit an IRA from someone other than your spouse, you must take distributions within 10 years of the death of the account owner.

What’s the penalty if I don’t take RMDs? 

If you neglect to take a required distribution by the deadline, you’ll owe a penalty equal to half the required distribution. So, if you were supposed to take $4,000 by April 1, and you don’t do it, you’ll owe an extra $2,000 to the IRS. 

That 50 percent penalty is considered an excise tax, and in addition to paying it, you’ll also have to file IRS Form 5329 to report it with your tax return. 

The penalty is tough, so it’s crucial to plan ahead for RMDs and be prepared to take them on time. By understanding the IRS required minimum distribution tables and the rules surrounding them, you can be prepared to start withdrawing retirement funds on time—and using them to build the retirement you’ve been saving for all these years.