A-Z Guide on Calculating Required Minimum Distributions
A Required Minimum Distribution, or RMD, is something you will definitely hear about if you are investing in traditional tax-advantaged retirement accounts like a 401(k) or an Individual Retirement Account (IRA). These types of accounts let you delay taxes, which is why the government wants to keep tabs on your withdrawals so that they can make sure they eventually tax you when you start taking money out.
The key thing to remember is that RMDs are mandatory. Therefore, you must take the required minimum distribution when the time comes. What differs is the amount of your RMD. This varies from person to person and depends on a few factors.
That is exactly what this article will dive into and help you understand the whats and the hows of how Required Minimum Distributions are calculated.
Here is an A to Z guide on everything you need to know about calculating a Required Minimum Distribution:
What is an RMD?
Let’s start with the basics. An RMD is a forced withdrawal from your retirement account, as you cannot leave your money untouched forever, growing tax-deferred. Once you turn 73, as of 2025, the Internal Revenue Service (IRS) will want to levy taxes on your account that has been sitting tax-free all this time. That is when your RMDs become an obligatory task.
RMDs apply to most traditional retirement accounts, including Traditional IRAs, the Simplified Employee Pension (SEP) IRA, the Savings Incentive Match Plan for Employees (SIMPLE) IRA, the 401(k) plan, the 403(b) plan, the 457(b) plan, profit-sharing plans, and other defined contribution plans. RMDs follow a simple rule where you must start taking withdrawals from these accounts once you reach the required age, regardless of your need for the funds.
You can withdraw more than the minimum amount, but you must withdraw at least the RMD. You cannot altogether skip the withdrawal. These withdrawals are considered taxable income, so you will pay income tax at the ordinary rates that apply to you for the relevant year.
Now, there is one exception that many people love, which is through the Roth IRA. If you are the original account owner, you do not need to take RMDs from your Roth IRA at all during your lifetime. The same applies to designated Roth accounts in a 401(k) or 403(b), as long as the account holder is still alive. However, beneficiaries of Roth IRAs or designated Roth accounts must follow RMD rules after inheriting the account.
How are required minimum distributions calculated?
Now, let’s move on to the main agenda, which is the calculation. Let’s get into the heart of it.
Let’s start with timing.
The first RMD must be withdrawn by April 1 of the year following the year you turn 73. This is known as your required beginning date. Let’s consider an example:
If you were born in 1951 and you are turning 73 in 2024, your very first RMD needs to be taken by April 1, 2025. After that, every RMD must be taken by December 31 of each year. The first year gives you a little extra time, but from the second year onward, you will be on a regular yearly schedule.
In the first year, you technically have two deadlines for taking your RMDs:
- One on April 1
- One on December 31
Let’s break this down with an example, too:
Say you turn 73 on July 15, 2024. Your first RMD is due by April 1, 2025. This RMD will apply for the 2024 tax year. But then, your second RMD for 2025 will be due by December 31, 2025. Therefore, you would end up taking two RMDs in the same calendar year, and both would be taxable for the year 2025.
Now you must be thinking that this will put you into a higher tax bracket, and it definitely will. So, what do you do?
Many financial advisors recommend that you take your first RMD before December 31, 2024, which is the year you actually turn 73. That way, your 2024 RMD is taxed in 2024 and your 2025 RMD is taxed in 2025.
So, what is the formula for calculating an RMD?
To figure out how much you need to withdraw, start by looking at your retirement account balance on December 31 of the previous year.
Next, go to the IRS’s Uniform Lifetime Table (specifically Table III in IRS Publication 590-B). This table provides a number known as a life expectancy factor. This factor differs depending on your age. You can find the table on the IRS’s website or even on third-party websites. If you are unable to find it, you can contact a financial advisor, who can provide you with one.
Now, just divide your account balance by that life expectancy factor.
Let’s say your account was worth $100,000.00 on December 31, and your life expectancy factor from the table is 26.5. To calculate your RMD, you would need to divide $100,000 by 26.5, resulting in an approximate RMD of $3,773.58 for that year.
Required minimum distribution formula: Account balance ÷ Life expectancy factor
$100,000 ÷ 26.5 = $ 3,773.58
It is essential to note that the Uniform Lifetime Table applies to account owners who are making withdrawals from their own accounts. But RMDs also apply to beneficiaries. If the account owner is no longer around, the beneficiary will inherit the account. They, too, need to satisfy the RMD rules.
However, in this case, the table used to calculate the RMD depends on the beneficiary’s relationship to the account and the beneficiary’s situation. Here are the different scenarios of how this works:
- If your spouse is more than 10 years younger than you and is your sole beneficiary, you can use the Joint Life and Last Survivor Expectancy Table (Table II).
- If you are a non-spouse beneficiary who inherited an IRA, you will use the Single Life Expectancy Table (Table I).
Everyone else, including most IRA owners, will use the Uniform Lifetime Table (Table III).
While you can find all of these tables online and calculate the value on your own using the RMD calculation formula, things can get complicated sometimes. You can find worksheets and calculators online to help simplify this process.
However, the safest bet is to work with a financial advisor. They can help you calculate your RMD accurately to ensure you do not make mistakes. They can also ensure that your withdrawals from retirement accounts align with your broader retirement income, tax situation, and financial needs.
How do I calculate my RMDs in the case of multiple retirement accounts?
As mentioned above, RMDs apply to both IRAs, including SEP IRAs and SIMPLE IRAs, as well as defined contribution plans such as 401(k), 403(b), and profit-sharing plans. However, the exact rules for calculating your RMD may differ for each of these accounts.
If you own multiple IRAs, such as a traditional IRA, you must calculate the RMD separately for each account. However, you can withdraw the combined total from just one IRA or divide the total withdrawal between several IRAs. There is no mandatory rule that you need to take a separate distribution from each IRA. The only thing that matters is that the total RMD is satisfied.
For example:
Consider an example where you have two IRAs. Your IRA balances look like this:
- IRA 1: $60,000
- IRA 2: $40,000
Now, in this case, your total IRA balance is $100,000. Assuming the same life expectancy factor of 26.5, you can calculate the RMD for each IRA individually like this:
- IRA 1: $60,000 ÷ 26.5 = $2,264.15
- IRA 2: $40,000 ÷ 26.5 = $1,509.43
So, your total RMD: $2,264.15 + $1,509.43 = $3,773.58
You must withdraw at least $3,773.58 total from your traditional IRAs for the year. However, you can withdraw it all from just one IRA, such as taking $3,773.58 from IRA 1 or splitting it between the two, with $2,000 from IRA 1 and $1,773.58 from IRA 2.
On the other hand, if you have multiple employer-sponsored defined contribution plans, such as 401(k) plans, 457(b) plans, as well as SIMPLE IRAs, you are required to calculate and withdraw RMDs from each account individually. You cannot combine withdrawals from these accounts, as you can with traditional IRAs.
For instance, if you have two 401(k) accounts, each with a balance of $100,000 and your life expectancy factor is 26.5, you must calculate the RMD separately for each account. The RMD from each account would be $100,000 ÷ 26.5 = $3,774. So, you would need to withdraw $3,774 from each 401(k) account individually, totaling $7,548 in one year.
There is one exception here, though. If you have multiple 403(b) tax-sheltered annuity accounts, you can calculate the total RMD across all 403(b) accounts and take the full amount from just one or split it among them, just like a traditional IRA.
Now that you understand how Required Minimum Distributions are calculated, you can determine your RMD values and prepare for the withdrawals. However, you may have other questions about RMDs as well. Here are some of those questions answered, so all your doubts are cleared.
1. Can you take more than one withdrawal in a year to meet your RMD requirements?
Yes, you may take more than one withdrawal in a year to meet your RMD. The IRS has no issues with the number of withdrawals and permits account holders to take the RMD in any number of installments, as long as the full required amount is withdrawn by the applicable deadline. In fact, you can also withdraw more than the RMD amount if you wish.
Note: Any excess taken in one year cannot be carried forward to adjust your RMD for future years.
For example, if your total RMD for the year is $3,774. You could choose to withdraw $1,000 in March, $1,000 in June, and the remaining $1,774 in November. As long as you withdraw the full $3,774 by December 31, you will have met your RMD requirement for the year. However, if you decide to withdraw $5,000 instead, the extra $1,226 will not reduce your RMD for the following year.
2. Are there any exceptions to taking RMDs?
Yes, there are. But only if you are still working at 73. If you are still employed and have a workplace retirement plan, such as a 401(k), there is an exception to RMDs. In such cases, you can delay your RMDs until April 1 of the year after you actually retire, as long as your plan allows it. For instance, say you turn 73 in 2024, you do not have to withdraw your first RMD by April 2025.
But even in these situations, there is an exception. If you are a 5% owner of the company, this exception will not apply to you. You will still need to begin RMDs by April 1 of the year following the year you turn 73, regardless of whether you are still working or not.
3. What happens if you do not take the RMD at all?
This is likely the most frequently asked question regarding RMDs. Not being able to withdraw your RMDs is not a crime. It does not land you in legal trouble. At the end of the day, it is your own money, and you can decide what you do with it. However, the money will be subject to taxation. These are taxes you owe to the government, and one way or another, you will need to pay them.
If you do not take the RMD or if you take an RMD that is less than what you need to withdraw in a year, the amount not withdrawn is subject to a 25% excise tax. For example, if your RMD for the year is $3,774 and you do not withdraw it, you would owe a 25% tax on the entire RMD. That equals $943.50.
If you make a partial withdrawal and draw only $2,000. The shortfall of $1,774 would be subject to a 25% excise tax, and you could owe $443.50 in taxes.
However, if you correct this mistake within two years, the penalty may be reduced to 10% instead of 25%.
Time to make the withdrawal
Now that you know how to calculate and withdraw your RMDs, you are ready to take the next step. If you ever feel unsure, you can always reach out to a financial advisor. Our free advisor match tool can help you connect with one. Hiring an advisor can be more useful than you think.
Not only can they help you calculate your RMD accurately, but they can also help you align it with your overall tax strategy. But if you prefer doing it yourself, keep a calculator handy and triple-check your math. A little caution goes a long way.
For further information on creating a suitable retirement plan for your unique financial requirements, visit Dash Investments or email me directly at dash@dashinvestments.com.
About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.
CEO & Chief Investment Officer Jonathan Dash has been covered in major business publications such as Barron’s, The Wall Street Journal, and The New York Times as a leader in the investment industry with a track record of creating value for his firm’s clients.
