How Much Will Your RMDs Be?

Required minimum distributions—or RMDs for short—are the government's way of turning up the house lights, turning off the music, and not selling any more drinks.

In other words, the party's over. You've gotten a tax-free ride on your traditional IRAs, 401(k)s, and other tax-deferred retirement accounts for however many years you've been investing in them. But once you hit age 72, the money has to start coming out of your accounts, and most important to the government, you need to pay taxes on those withdrawals. If you don't comply and take the money out on time each year, the penalties are steep—any taxes that were due on the RMD amount, plus an extra 50% penalty on the amount that you should have taken but didn't.

Which Accounts Are Subject to RMDs?

Required minimum distributions apply to 401(k), 403(b), traditional IRA, and other types of retirement accounts, including solo 401(k)s and SEP and Simple IRAs. If you're still working at age 72, you may be able to delay taking RMDs from your 401(k) until you retire, if your plan allows you to do so. (RMDs also apply to inherited IRAs, but this article will focus on RMDs from individuals' own retirement accounts.)

One retirement account type that is a notable exception to the RMD rules is the Roth IRA, which does not require minimum distributions at all while the accountholder is still living. By contrast, Roth 401(k)s do impose RMDs, but those can usually be readily circumvented by rolling the funds into a Roth IRA. Being able to avoid RMDs and in turn allowing the money to grow throughout retirement is a key benefit of Roth IRAs. Of course, that tax-savings feature only applies to those retirees who are lucky enough to not need those funds for spending.

A Simple Formula

The process for calculating RMDs is fairly simple: It involves dividing the retirement account's balance as of the previous year-end by what the Internal Revenue Service calls a life expectancy factor. For people taking RMDs in 2022, for example, they'd look back to their balances as of year-end 2021 when determining how much to take out.

The wrinkle for RMD calculations in 2022 (starting on Jan. 1 of this year) is that they rely on new tables for life expectancy that reflect slight improvements in longevity. The net effect of those new tables is that RMD amounts will be slightly lower for 2022 than they were under the tables previously in force. Even people who had been previously taking RMDs under the old tables will use the new tables instead.

Most accountholders—single people and married people with spouses who are less than 10 years younger than them—will use what's called a Uniform Lifetime Table to calculate their RMDs. A separate table applies to accountholders with spouses who are more than 10 years younger and who are sole beneficiaries. This allows accountholders whose husbands or wives are expected to outlive them by many years to keep more of their assets in tax-advantaged retirement accounts on behalf of their spouses. A third table, the Single Life Expectancy Table, aids in calculating RMDs for beneficiaries after an accountholder dies. (Note that the Secure Act ushered in new rules for inherited IRAs.)

Digging Into the Numbers

From a practical standpoint, the fact that RMDs rely on life expectancy means that you must withdraw a higher percentage of your portfolio as you age. That might not translate into a higher withdrawal amount with each passing year, however, because your portfolio's growth (or losses) will also influence your withdrawal amounts. If your portfolio shrinks, your RMD amount may be smaller than that of the previous year, even though it's a higher percentage. Note that there's also a bit of a lag effect, because your RMD is based on the previous year's balance. The years 2021 and 2022 provide a good illustration. Even though the market is down so far in 2022, RMDs for many accountholders are apt to be elevated this year because they rely on portfolio balances as of year-end 2021, after stocks had rallied.

But all else being equal, RMDs generally rise as a percentage of the portfolio as the accountholder gets older and the number of years of life expectancy decreases. For example, a 73-year-old accountholder who had an IRA balance of $500,000 at year-end 2021 must take $18,868 in RMDs for 2022, based on the new tables. By contrast, if an 80-year-old had the same amount in the account, he or she would have to take $24,752 in RMDs in 2022. The former is a 3.7% withdrawal rate, whereas the latter is a 5.0% withdrawal rate.

That raises the question of how RMDs affect portfolio withdrawal rates and whether RMDs could force you to withdraw more than you intended to. The short answer is not really. After all, they're required minimum distributions, not required minimum expenditures. You can't avoid the tax bill on RMDs, but there's no reason you can't reinvest any RMDs you don't need back into your accounts--an IRA if your earned income covers the contribution amount or, more typically, a taxable brokerage account.

For Multiple Accounts, Special Rules Apply

For investors with multiple retirement accounts, calculating RMDs gets a little more complicated. For 401(k)s and most other retirement plans, RMDs must be calculated separately for each account and distributed accordingly from each account. For IRA and 403(b) accounts, however, investors may calculate RMDs for each account, total them up, and then take the entire distribution from just one of them. So, if an investor has to take RMDs of $12,000 from one IRA and $8,000 from another, he or she could take the entire $20,000 RMD from just one of the two accounts. For people with multiple IRAs, that leaves open the opportunity for strategic RMD-taking: taking the distribution from whichever IRA is most beneficial from an investment standpoint and leaving the others alone.

Because RMD-subject accounts are owned individually, they must be calculated on an individual basis. Married people who are both subject to RMDs can't combine their RMD amounts and take the distribution from one partner's account.

Steep Penalty for Missing RMDs

RMDs are taxed as regular income except for any assets that have already been taxed (for example, contributions to a nondeductible IRA). The administrator of the retirement account typically will calculate RMDs for the accountholder--and distribute them automatically if requested. But it is the accountholder who is responsible for making sure he or she receives the proper distribution amount; the penalties for failing to do so are steep. If an accountholder fails to pull enough money out of a retirement account to meet the RMD by the end of a given year, he or she faces a 50% tax on the undistributed amount, on top of the taxes that are due on any IRA distribution. So, if you are required to withdraw $50,000 in a given year but only take out $40,000, that $10,000 shortfall is going to cost you $5,000 in extra taxes. The penalty might be waived, however, if the account owner can convince the IRS that the shortfall was the result of what the agency calls a reasonable error, and he or she then takes steps to rectify the situation.

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