What is a Required Minimum Distribution?
As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, many of my clients are people who are either immediately or distantly interested (or concerned) about retiring! Retirement is a beautiful time in people's lives where they can reap all of the benefits of a hard-working life; however, more important than working hard… is working smart. Not only do you want to work smart, but you want your money to work smart. This fact leads many people who are considering their own retirement to start putting their money in tax-deferred accounts, like IRAs.
What's a tax-deferred account? Tax-deferred is precisely what it sounds like. You put your money before tax is paid in and don't pay taxes on it until later. These are incredibly wonderful if you're investing and want to enjoy the maximum benefits of financial principles like compounding growth and interest. Methods like this will allow you to grow your investment at a rapid pace and worry about paying taxes on it later when it's withdrawn. So… how does required minimum distribution come into the mix?
What is a Required Minimum Distribution (RMD)
Eventually, you must pay the piper. A required minimum distribution, or RMD, is the IRS's payday when it comes to your tax-deferred accounts. It's their way of avoiding you never paying taxes on your money. When you reach a certain age, the IRS begins to require you to take out a specific amount of money from your IRA or other tax-deferred accounts annually - this is called a required minimum distribution.
Everyone's required minimum distribution is different. Your required minimum distribution is calculated differently depending on your age, the type of account you have, and the balance of your account. To find out how to calculate your specific RMD, you should contact an accountant or a CERTIFIED FINANCIAL PLANNER™ (like me!) However, for most who have a traditional IRA, you need to find the account balance, find your distribution factor using the IRS's worksheets and divide. Here's a great example from Investopedia:
"…an account holder age 75, Bob's IRA had a balance of $205,000 on Dec. 31 of the previous year. The distribution factors from the relevant IRS table are 22.9 for age 75.
The required minimum distribution is calculated as: RMD = $205,000 ÷ 22.9 = $8,951.97. So Bob needs to withdraw at least $8,951.97.”
Your required minimum distribution isn't only different than everyone else's; it will change from year to year and from account to account. You shouldn't ever use "last year's numbers" to try and figure out your required minimum distribution. Instead, you should freshly calculate it for each required account every year. A easy way to stay on top of this is by enlisting the help of a CERTIFIED FINANCIAL PLANNER™ or accountant.
What is the RMD Age?
Before 2020, the age that you would need to begin taking your required minimum distribution was the year you turned 70 1/2. However, now the age that you must begin drawing your required minimum distribution is 72. This change happened under the CARES act passed by Congress in 2019. The CARES act, which was passed to relieve financial hardships caused by coronavirus, allowed account holders to pass on taking an RMD in 2020; however, this is a rare occurrence and shouldn't be expected to happen again any time soon.
When Do You Need to Take Your RMD Each Year?
Though the age at which you are required to begin taking your required minimum distribution has changed recently, the date hasn't. The year you turn 72, you must take your first required minimum distribution by April 1st. However, each year afterward, you'll be required to take your required minimum distribution by December 31st. If there's any confusion on when you will/won't have to take your RMD, be sure to reach out and talk to a CERTIFIED FINANCIAL PLANNER™ or financial coach who will be able to look up your RMD dates using your birthday. Also, you'll want to be very sure that you get your required minimum distribution in on time each year…
What Happens if Your Required Minimum Distribution is Late?
It's essential to take the correct amount on time for your RMD. In fact, if you don't, you'll be heavily penalized. If you don't take your required minimum distribution on time, the IRS will penalize you FIFTY PERCENT of your calculated RMD. For example, if you needed to take $10,000 in required minimum distribution and it was late, you'd be fined $5,000 by the IRS. Because of this heavy fine, it's always worth taking your required minimum distribution and paying the taxes you owe on it.
Do I HAVE to Withdraw my RMD?
Yes, but… not exactly. Your required minimum distribution must be moved from the tax-deferred account. However, this doesn't mean that you have to take it and put it in your pocket. You can always keep that money working as an investment in a non-tax-deferred account. Meeting with a financial representative or financial planner is perhaps the best way to determine what you can do with your required minimum distribution without "fully" withdrawing it.
Required Minimum Distributions Summed Up
So, we've gotten quite a bit of information from a few different angles about required minimum distributions. Let's quickly summarized what we've put together.
A required minimum distribution, or RMD, is the IRS's way of making sure they're eventually paid for any money that's been put in a tax-deferred account. These are generally calculated using your balance, account type, and age and can be taken out and put into your pocket or used in a taxed investment account. The age at which you must begin annually taking a required minimum distribution is seventy-two and a half, and it's due April 1st, your first year, and December 31st, each year after that. Taking your required minimum distribution and paying taxes on it each year is critical, as it helps you avoid a substantial fifty-percent penalty to the IRS.
A CERTIFIED FINANCIAL PLANNER™ Can Help you create a plan for your Required Minimum Distributions
If you're concerned about required minimum distributions, or retirement, I'd highly recommend meeting with a financial planner or financial advisor representative. People like myself can help you understand the ins and outs of the economic laws that apply to you. If you'd like to discuss your options for retirement or your required minimum distribution, please, feel free to call or email to schedule an appointment with me. Together we can create a financial plan that helps you become debt-free, make a savings security blanket, and put your money to work for you!
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.