What is a required minimum distribution?

A required minimum distribution, or RMD, is the specific amount of money that the IRS requires you to withdraw from certain retirement plans the year after you turn 72.

After decades of contributing to your retirement plan, you might be approaching the time to start taking money out of it. Some retirement accounts have required minimum distributions. These accounts include:

  • Employer-sponsored retirement plans, including most 401(k), 403(b) and 457(b) plans
  • Traditional IRA
  • Rollover IRA
  • Roth 401(k)
  • Other defined contribution plans

The IRS requires that account holders of some retirement plans start taking required minimum distributions when they reach a specific age. In 2020, the age went from 70 1/2 years of age to 72. This isn’t based on income or need. It’s only based on the type of account you have and your age.

How required minimum distributions work

With most retirement accounts, you contribute on a tax-deferred (or pretax) basis and your money grows tax-deferred for as long as you have it. But when you hit 72, you’ll need to start taking money out of your account. Those distributions are deemed taxable income.

Your first RMD is calculated by how much you have in your tax-deferred retirement account at the end of the year before turning 72. Each following year, an RMD is calculated by taking the year-end account value divided by the account owner’s life expectancy factor based on mortality rate tables.

Remember these are minimum distributions. You can always take out more. Additionally, you can set up automatic withdrawals — whether in one lump-sum, quarterly or at any other points during the year — as long as you take out at least the minimum amount.

When do required minimum distributions not apply?

Not all retirement accounts have RMDs. Roth IRAs don’t require minimum distributions, and withdrawals aren’t required until years after the owner dies. If you have a Roth IRA, you’re not required to take a minimum distribution and can continue making contributions as long as you’d like, so long as the account owner has earned income and is under the income limits (AGI) to make the contribution.

How to calculate a required minimum distribution

The required minimum distribution is calculated by taking the account balance as of Dec. 31 of the previous year and dividing it by a life expectancy factor from the IRS. The IRS makes updates often, so check their site for new developments. Use the IRS worksheet and appendices to calculate your figures.

Your calculations also depend on how many beneficiaries you have as well as their ages, since life expectancy is calculated for all of you. Along with that, there are different distribution amounts for accounts where the owner has died.

You’ll be able to find the balance on the year-end fair market value statement you get every year and you’re required to report the amount of the RMD, along with the date you’ll first take the distribution. Some accounts don’t require reports, like 403(b) plans. If the owners of the plan have died, reports don’t need to be filed either.

There’s no RMD for an account where the owner died on or after the required beginning date. You’ll figure out the RMD for an account where the owner died as if the owner lived for the entire year. After the first year after the original owner passed, you’ll use the age of the beneficiaries to calculate RMDs. Keep in mind that your personal designation as a beneficiary matters to when you start taking an RMD.

How required minimum distributions are taxed

In general, required minimum distributions are taxed at ordinary income rates. If your contributions to the retirement account were tax-deductible when you made them, then you’ll be taxed on the distributions.

Roth IRAs do not have RMDs as long as the original account owner is still alive. Rules vary for inherited Roth IRAs, but those distributions are tax-free as long as certain conditions are met, such as the five-year rule.

Required minimum distribution example

For example: You turn 72 years old this year and your partner turns 70. Using the tables provided by the IRS, your average life expectancy is 26.5.

Say you have $500,000 as of Dec. 31 of last year. Take $500,000 and divide by 26.5. Your required minimum distribution this year is $18,868.

What happens if you don’t take a required minimum distribution?

If you don’t take a required minimum distribution, you could get charged with a 50 percent tax penalty on the amount that should’ve been distributed.

Say you only took out $15,000 of the $18,868 from the example above. You’d be penalized 50 percent on the remaining $3,868, so you’d owe $1,934 in taxes to the IRS for missing the RMD.

Take the time to review IRS publications and documents to make sure you’re reporting the most accurate information you have. If you take out less than you need to, it could cost you. Make sure you’re taking out at least the required amount to avoid facing a fee.

The less you have in your retirement account, the less your RMD will be. But remember that money has to stretch for your entire retirement so the more you have in the account, the more financially comfortable you’ll be in retirement.

— Bankrate’s Brian Baker contributed to an update of this story.