Understanding Your Required Minimum Distribution
One of the most common questions we hear from clients is “how are you calculating my required minimum distribution (RMD)”?
For those who are not familiar with the term RMD, the Internal Revenue Code requires owners of retirement accounts to begin taking money out of these accounts every year once reaching age 73, this is known as a required minimum distribution. Since these accounts have benefited from tax-deferred growth. this is Uncle Sam’s way of getting his share.
Types of accounts that require minimum distributions
The required minimum distribution rules exist because of the tax benefits provided by qualified retirement plans.
401(k)/403(b) plans
Traditional and Rollover IRAs
SEP/Simple IRAs
Inherited IRAs
These types of accounts offer tax deductions on the contributions (up to a certain limit) as well as tax-deferred growth on earnings. If you have inherited an IRA it comes with RMD responsibilities, as well. The rules governing how the RMD rules apply in this situation will depend on the relationship to the deceased owner (i.e. spouse, non-spouse, or entity). Roth IRAs do not require distributions. This is because the dollars you contributed into a Roth IRA during your lifetime was already taxed.
When to start taking the RMD
Once you turn 73, you are obligated to begin withdrawing your RMD. In that first year only, you have until April 15th of the following year to take your RMD. Thereafter, you must take the distribution by December 31st or face a stiff penalty.
Calculating the RMD withdrawal
The RMD is calculated by dividing the market value of the account as of December 31st of the preceding year by an applicable life expectancy factor taken from the IRS’s Uniform Lifetime Table. (Most IRA owners will use this table to calculate their RMD.) The factor to be used is determined by your age at the end of the year for which you are taking the distribution. As the account owner gets older, the factor (denominator in the equation), is subsequently reduced.
Example: Calculating the 2024 RMD for a Traditional IRA using the Uniform Lifetime Table
Account owner turned 73 in 2024
IRA balance as of 12/31/73 = $274,000
Factor = 27.4
RMD = $274,000/27.4 = $10,000 RMD which must be distributed by 12/31/2024!
If the primary beneficiary on the IRA account is a spouse who is more than 10 years younger than the owner, the Joint Life Expectancy Table is used to calculate the RMD.
Penalty for missing the RMD
If you don’t take the required minimum distribution from the retirement account, the penalty is equal to 50% of the amount that should have been withdrawn. For example, if the expected RMD was $10,000 the penalty for not withdrawing assets by the end of the calendar year would be $5,000! (The account owner would now be responsible for the $5,000 penalty in addition to the $10,000 RMD that is still owed).
What if I don’t need the income?
The IRS requires RMDs to be taken whether or not the income is needed. Oftentimes clients will choose to reinvest the RMD into a taxable investment account while others may choose to have a check distributed for the amount. It is important to note that once an individual has reached age 70 ½, the first dollars that are pulled out of retirement account (such as a traditional IRA) are counted towards the RMD for the year. (Due to the nature of the taxable event, RMDs are not allowed to be redeposited.)
For individuals who have charitable giving plans it may be beneficial to designate the RMD as a Qualified Charitable Distribution (QCD). Generally, a Qualified Charitable Distribution is a tax-free distribution directly from an IRA to a charity. In order to obtain the tax benefits for doing a QCD, there are very specific requirements to be met which include a minimum age, maximum dollar amount and contributions made only to eligible public charities. Most importantly, the check cannot be made payable to the IRA owner and instead must be made payable directly to the charitable entity. (Private foundations and donor-advised funds are ineligible charities for qualified charitable contribution purposes.)
It is crucial for account owners to understand what their obligations are for satisfying their required minimum distribution. Most financial institutions will provide the RMD calculation, but it is your responsibility to make sure you have taken all of the required RMDs for the year.
If you or anyone you know has questions about an RMD, please contact Westview today to discuss your situation. If you are a client of WestView Investment Advisors, RMD calculation and processing is a complimentary service we provide.
