Most people don’t celebrate “half-birthdays” unless their big day happens to fall on or near a major holiday. But it’s important that you mark the day you turn 70 ½ on your calendar. That’s because, once you reach this milestone, the IRS requires you to start taking distributions from your retirement accounts. These distributions are called required minimum distributions (RMDs).
All retirement accounts — including workplace retirement accounts such as 401(k)s as well as IRAs — are subject to this requirement. So what do you need to know about RMDs when it comes to your IRA?
How Big Is Your RMD?
In general, the amount you must withdraw is determined by dividing the balance in your IRA at the end of the prior calendar year by a “distribution period” that the IRS has established.
This table presents some ages and the distribution periods associated with them.
So, for someone age 70 with a $500,000 IRA balance, their RMD would be $18,248 ($500,000 divided by 27.4). For a 90-year-old with the same balance, the RMD would be $43,860.
(Note: You’ll find the IRS’s complete table of distribution periods, plus the single life expectancy table in IRS Publication 590-B.)
When Must You Take Your RMD?
RMDs must be taken by the end of each calendar year and are determined by the balance in your IRA account at the end of the prior calendar year. So for 2017, your RMD would be based on the balance in the account as of Dec.31, 2016, and must be taken by Dec. 31, 2017.
Don’t stress about forgetting to take your RMD. If you have a traditional IRA account through a broker, mutual fund company or other reputable custodian, they will notify you each year about your required minimum distribution due during that calendar year. The IRS requires that they do this, as well as reporting the amount to the agency.
What If You Have Multiple IRAs?
If you have more than one IRA, you will still receive a notification of the amount of the RMD for each account. With IRAs, however, all that matters is that you take the total amount required between all your accounts.
For example, if you have three IRA accounts with required distributions totaling $30,000 you may take the entire amount from one account or any combination of accounts as long as the total distribution is at least $30,000.
Is Your RMD Taxable?
The RMD amount will be taxable; it is your choice whether to have federal and state taxes withheld. In the case of a $30,000 RMD, this amount will flow through your tax return as ordinary income on top of any other taxable income that you might have for the year, and your tax bill will be figured accordingly.
However, there’s an exception: Any money in a traditional IRA that was contributed with after-tax dollars will be included in the amount of the RMD but will not be taxed. The distributions will be done on a pro-rated basis taking into account the relative post- and pre-tax amounts in the account.
When Can You Defer Taking Your RMD?
For the first RMD only, you have the option to defer taking the distribution until April 1 of the calendar year following the one in which you reach age 70 ½. Understand, however, that this will result in you taking two distributions during that calendar year.
As an example, if you reach 70 ½ in 2017 you can defer taking the RMD based on the amount in your account on Dec. 31, 2016, until April 1, 2018. But you will also be required to take an RMD based on the balance in your account at Dec. 31, 2017, by the end of 2018.
This option can be useful if you have an unusually high level of taxable income in the year you turn 70 ½. For many of us, however, it might be better just to take the first-year distribution in the appropriate year.
What If You Inherited an IRA?
An inherited IRA is a specific type of IRA that is inherited from account holder to another. A spousal beneficiary can treat the IRA account as his or her own. (Use the Joint Life Expectancy table in IRS Publication 590-B if the spouse is the primary beneficiary and is more than 10 years younger than the account holder to determine the RMD.)
For others, the account balance needs to go into an inherited IRA account that is not to be co-mingled with any other IRA account the beneficiary might have.
RMDs are required here. If the original account holder was taking RMDs at the time of their death, then the RMDs must continue. For younger beneficiaries, the advantage is that the RMD would be based upon your life expectancy, allowing you to take a small distribution and to stretch the tax-deferral of the account for a longer period. (You can use the Single Life Expectancy table in IRS Publication 590-B to determine your RMD amount.)
If the account holder was not taking RMDs at the time of their death, you are not required to do so until you reach age 70 ½.
Can You Donate Your RMD?
For those who are charitably inclined, up to $100,000 of your RMD can be donated to a qualified charitable organization. The amount will not be included in your taxable income for the year, though you will not receive a deduction for the charitable contribution in addition to having the distribution excluded from your taxable income.
What About Roth IRAs?
One of the benefits of Roth IRAs is that they are exempt from RMDs as long as certain rules and requirements are followed. If the beneficiary of your Roth account is your spouse, they are also exempt from taking RMDs. This makes a Roth IRA an excellent vehicle for estate planning purposes.
For non-spousal beneficiaries, there are two options when inheriting a Roth IRA. They can take the amount as a non-taxable lump-sum. Or they can roll the amount into an inherited Roth IRA account and begin taking RMDs by Dec. 31 of the year after the death of the account holder. If that deadline is missed, they then have five years to withdraw the entire amount from the account. None of these distribution options are subject to income taxes.
What If You Don’t Take Your RMD?
The penalty for not taking your RMD is 50% of the amount not taken, plus the taxes that have would normally been due. In some cases you can appeal the penalty on a missed RMD and the IRS will decide whether to enforce it.
RMDs from an IRA can be complicated and costly… especially if you’re not prepared. Be sure that you understand what is required, and don’t be afraid to seek the help of a qualified tax or financial advisor if needed.