How Much Will My RMDs Be?
Calculating required minimum distributions is relatively straightforward, but beware of complications.
Note: This article is part of Morningstar's 2018 Guide to IRAs special report. An earlier version of this article appeared on Aug. 28, 2012.
Q: I plan to retire in a few years and know I'll need to take required minimum distributions from my IRA once I turn 70 1/2, but I don't have a good sense of how much they'll be. How are they calculated?
A: Investors with 401(k), 403(b), traditional IRA, and other types of retirement accounts must take required minimum distributions, or RMDs, usually starting the year in which they turn 70 1/2. Think of it as the government's way of saying, "OK, we've let you invest for retirement on a tax-deferred basis for years, but now it's time to start moving money out of these accounts so we can tax it." Some employer-sponsored plans allow those who continue working beyond 70 1/2 to delay taking distributions until they retire.
Many investors take out more than the RMD from their retirement accounts each year or exhaust those accounts before they even reach age 70 1/2. However, others who don't need to tap their accounts or who take little out of them still need to make sure they take RMDs lest they incur costly penalties, which we'll discuss a little later. For the first year of RMDs, retirees have until April 1 of the following calendar year to take distributions; the deadline is Dec. 31 for all other years.
One notable exception to the RMD rules is the Roth IRA, which does not require minimum distributions at all while the account holder is still living. This is yet another feature that makes the Roth IRA so attractive for some investors. With no required minimum distributions, investors with Roth IRAs can continue to enjoy tax-free growth and withdrawals from the account indefinitely, making it a great vehicle for retirement assets the investor plans to tap last. This exemption does not apply to Roth 401(k)s, however, which are subject to RMDs. That's why it makes sense for retirees with Roth 401(k)s to think seriously about rolling them into a Roth IRA, especially if they would rather not have to take RMDs.
A Simple Formula As for calculating RMDs, the process is relatively straightforward and is based on the amount held in the retirement account and the life expectancy of the account holder. To determine RMDs for a given year, the account's market value at the end of the previous year is divided by what the Internal Revenue Service calls a life expectancy factor, based on how long the account holder is expected to live. This number is published by the IRS in a uniform lifetime table that applies to most account holders. A separate table applies to account holders with spouses who are more than 10 years younger and who are sole beneficiaries. (Both tables can be found in Appendix C of this IRS document). In the latter case, the ages of both the account holder and the spouse are factored in. This allows account holders 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 aids in calculating RMDs for beneficiaries after an account holder dies. (This article discusses the ins and outs of inherited IRAs.)
All else being equal, RMDs generally rise as a percentage of the portfolio as the account holder gets older and the number of years of life expectancy decreases. For example, an account holder with an IRA balance of $500,000 at year-end 2017 and who turned 70 1/2 during the first six months of this year must take $18,248 in RMDs for 2018 (though he or she has until April 1, 2019, to do so). By contrast, if that same account holder were turning 80 this year and had the same amount in the account, he or she would have to take $26,738 in RMDs. Of course, any extra distributions or investment gains and losses that happen from year to year also affect RMD amounts, so projecting out what they'll be during the course of a full retirement can be tricky.
The IRS provides worksheets, found here, to help taxpayers determine RMDs, and you'll find easy-to-use RMD calculators on the FINRA and Vanguard websites, among others.
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.
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 account holder--and distribute them automatically if requested. But it is the account holder that is responsible for making sure he or she receives the proper distribution amount; the penalties for the failing to do so are steep. If an account holder 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 the shortfall was the result of what the agency calls a reasonable error, and he or she then takes steps to rectify the situation.
No discussion of RMDs would be complete without a mention of various strategies to get the most out of your retirement accounts, including which accounts to tap first and smart ways to schedule distributions. This article covers where IRAs belong in your retirement funding queue.