Trillions of dollars are held in Individual Retirement Accounts (IRAs), but no dollars will remain in those IRAs forever. Traditional IRAs are tax-deferred assets, meaning income taxes are not paid when money is contributed to the accounts, but income taxes are due when money is distributed from the accounts. To prohibit the indefinite deferral of income taxes on IRA assets, the IRS established Required Minimum Distribution rules to ensure all IRA assets will eventually be distributed and taxed. If the Required Minimum Distribution (RMD) rules are not followed, the IRS will assess a 50% penalty tax on any IRA assets not distributed as required.
The first RMD from an IRA must occur before April 1 of the year following the year the IRA owner reaches age 70 and 1/2. The second RMD must occur before December 31 of the year following the year the IRA owner reaches age 70 and 1/2. All subsequent RMDs must occur before December 31 of each following year, and the RMDs continue annually for the remaining lifetime of the IRA owner. An IRA owner may begin taking distributions before age 70 and 1/2, but those earlier IRA distributions will not affect the RMD rules that apply once the owner reaches age 70 and 1/2.
The RMD may be taken as any number of withdrawals throughout the year as long as the sum of those withdrawals is equal to at least the RMD amount for that year. An individual may withdraw more than the RMD amount, but withdrawals in excess of the RMD for the current year cannot be applied to the RMD for future years. If an individual has more than one IRA, the RMDs must be calculated for each IRA but do not need to be withdrawn from each IRA proportionately as long as the individual’s total IRA withdrawals for the year are equal to at least the sum of the RMDs for all the IRAs.
The amount of the RMD for each year is calculated by dividing the previous year-end balance of the IRA by a distribution period number which depends on the age of the IRA owner and/or the beneficiary of the IRA owner. In most cases, the applicable distribution period is found in the Uniform Lifetime Table in Appendix C of IRS Publication 590. The IRA owner must use the distribution period number that corresponds with the age he or she attains each year. If the spouse of the IRA owner is more than 10 years younger than the IRA owner and is the sole beneficiary of the IRA, the applicable distribution period is found in the Joint Life and Last Survivor Expectancy Table in Appendix C of IRS Publication 590.
These RMD rules apply to traditional IRAs but not to Roth IRAs. For Roth IRAs, income taxes are paid when money is contributed to the accounts, but income taxes are not due when money is distributed from the accounts. The IRS has little reason to require distributions from Roth IRAs during the lifetimes of Roth IRA owners because those distributions are generally tax-exempt. Now following is an example of how the RMD calculation applies to traditional IRAs.
Abuela has two IRAs, and the balances of those IRAs at the end of last year were $60,000 and $90,000. Her 70th birthday is in May of this year, so she reaches age 70 and 1/2 in November of this year. She will be required to take her first RMD before April 1 of next year. She references the Uniform Lifetime Table and finds the distribution period is 27.4 for the year she turns age 70. She divides her $60,000 IRA balance by 27.4 to calculate her RMD for that account is $2,190. She divides her $90,000 IRA balance by 27.4 to calculate her RMD for that account is $3,285. Abuela must withdraw at least $5,475 combined from her two IRAs between now and April 1 of next year.
Abuela’s two IRA balances at the end of this year are $50,000 and $80,000. Her 71st birthday will be next year, and so she will be required to take her second RMD before December 31 of next year. She references the Uniform Lifetime Table and finds the distribution period is 26.5 for the year she turns 71. She divides her $50,000 IRA balance by 26.5 to calculate her RMD for that account is $1,887. She divides her $80,000 IRA balance by 26.5 to calculate her RMD for that account is $3,019. Abuela must withdraw at least $4,906 combined from her two IRAs between January 1 and December 31 of next year.
The Required Minimum Distribution rules are not overly complicated, but should be strictly followed to avoid severe tax penalties. Additional details about IRAs and RMDs can be found in IRS Publication 590. The IRS also provides RMD worksheets for guidance in these calculations. If you have an IRA and would like help calculating and planning for RMDs, please contact your accountant or financial planner for assistance.