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What are required minimum distributions (RMDs)?

RMDs are annual withdrawals from a retirement account, mandatory under IRS rules. RMDs impact those who reach a specified age and, in some cases, those who have inherited IRA accounts as a beneficiary. The SECURE Act raised the age to commence RMDs from 70½ to 72, beginning in 2020. This legislation also changed the rules surrounding inherited IRAs.

Due to the coronavirus pandemic, RMDs have been waived for nearly everyone in 2020 under the CARES Act. The CARES Act included a number of provisions to assist individuals and businesses in easing the financial impact of the COVID-19 pandemic. This included a waiver for RMDs for most types of retirement accounts, including IRAs, 401(k)s, 403(b)s, and others. It also covered the beneficiaries of inherited IRAs.

However, relief from the CARES Act does not apply to any RMDs associated with a defined benefit pension plan.

Unless there is some additional legislation enacted, at this point retirement account holders will have to resume their RMDs as normal in 2021. We recommend using Empower or Betterment to handle your retirement savings efficiently.

How to calculate required minimum distributions (RMD)

RMDs for the current year are calculated based on the account balance as of December 31 of the prior year. For example, RMDs for 2021 will be based on the account balance of December 31, 2020.

To calculate your RMD, you need to take the December 31 account balance and divide it by the appropriate factor in the IRS RMD tables.

There are three main required minimum distributions tables:

  1. The Uniform Lifetime Table is what most people will use. It is for those who are unmarried owners, married with a spouse who is not more than 10 years younger, and married owners whose spouse is not the sole beneficiary of their IRA.
  2. The Joint Life Expectancy Table is used only when your spouse is at least 10 years younger than you are and only if your spouse is the sole beneficiary of the account for the entire year. If your spouse who fits this description were to die during the year, the account owner would use this table for that year but not for the following year. Likewise, if the older spouse were to die and the younger spouse had reached an age where they must take their RMD, they would use this table in that year, but then use the Uniform table in subsequent years assuming they made the IRA their own.
  3. The Single Life Expectancy Table is used only by retirement account beneficiaries. The account holder will never use this table during their lifetime. In the case of a spousal beneficiary, they are eligible to roll an IRA or other inherited retirement account into their own IRA in most cases. In this situation, they would use the table and factors that apply to their own situation.

Let's look at the Uniform Lifetime Table as an example. You'll find that the factor gets smaller each year. Dividing by a smaller number means a greater percentage is being withdrawn. So you'll most likely end up needing to take out more from your retirement accounts each year, unless the amount in your accounts drops significantly.

Many retirement plan administrators provide a calculator to figure the RMD amount for the year. Charles Schwab offers one I've used in the past.

However, the regulations require plan administrators to calculate and notify account holders of their RMD amount each year. So you don't have to bother figuring your own withdrawal amount. Administrators must also report the withdrawal amount to the IRS each year.

RMDs when you have multiple accounts

For those who have multiple retirement accounts, there are a couple of options. You can take the entire RMD from one IRA account or any combination of your IRA accounts. The key is that the total dollar amount of the RMDs from all IRA accounts combined must be withdrawn from at least one of your IRA accounts. This includes rollover IRAs, SEP-IRAs, and SIMPLE IRAs, as well as 403(b)s.

This doesn't apply to other types of retirement accounts. If you have old 401(k) accounts with former employers, then the amount of the RMD for each of the accounts must be taken specifically from that account.

What if you withdraw too little or don't take an RMD?

If you don't take an RMD or take a distribution that is below the required amount, the penalties are steep. You pay a penalty of 50% of the amount not taken, plus you are still liable for the taxes that would normally be due.

For example, if your RMD should be $20,000 and you withdraw only $10,000, you would be given a $5,000 penalty. You would still be liable for the tax on the full $20,000. For that reason alone, it's important to know your RMD each year and withdraw the required amount.

Required minimum distributions deadlines and exceptions

RMDs for the current year is calculated based on the account balance as of December 31 of the prior year. For example, the account balance as of December 31, 2020, determines the RMD for 2021.

You must withdraw the required amount by the end of the applicable calendar year (except for in 2020, as they were eliminated due to the Covid-19 pandemic).

An exception to this occurs in the year that the first RMD is taken. You can delay your first year's RMD until April 1 of the year following your 72nd birthday. But this means you must take two RMDs that year, one by April 1 and the second by December 31. Each subsequent year's RMD must be taken by year's end.

How are RMDs taxed?

Generally, the entire amount of any RMD is fully taxable at the account holder's ordinary income tax rate for federal tax purposes. It may also be subject to state income tax. Check your state's rules as some states do not tax withdrawals from retirement accounts. This applies to both RMDs taken by the account holder and by beneficiaries of inherited IRAs.

If you made after-tax contributions to an IRA or employer retirement account similar to an IRA, these amounts would not be subject to tax. However, you need to have kept track of these amounts and will be required to file an IRS form each time this occurs.

Another exception is an RMD from a designated Roth 401(k) account. Minimum distributions are required from these accounts, but they are tax-free as long as the qualified distribution rules are met.

Required minimum distributions (RMD) rules

Account-holders of most retirement plans must take RMDs each year. These accounts include:

  • IRA accounts — Traditional IRAs are subject to RMDs while Roth IRAs are not. These rules apply to rollover IRAs as well. RMDs also apply to SEP-IRAs and to SIMPLE IRAs.
  • 401(k)s and 403(b)s — Both traditional 401(k) and designated Roth 401(k) options are subject to RMDs. These rules also pertain to 403(b) accounts in most cases. The RMDs for designated Roth 401(k) accounts are generally not taxed.
  • Small business retirement accounts — RMDs also apply to small business retirement accounts such as solo 401(k)s.

RMDs and inherited IRAs

The SECURE Act changed the landscape of RMDs for inherited IRA accounts, which was already a complex topic. In general, the SECURE Act eliminated most non-spousal IRA beneficiaries' ability to stretch their inherited IRA by using RMDs. Starting with IRAs inherited on or after January 1, 2020, most non-spousal IRA beneficiaries must withdraw the entire account balance within five years of inheriting the IRA. This includes traditional IRA accounts as well as Roth IRAs.

The only beneficiaries who can still inherit an IRA and stretch it using RMDs include the following eligible designated beneficiaries:

  • Spouses who can treat the account as their own.
  • Minor children of the account owner until they reach the age of majority. At that point, the five-year countdown begins.
  • A non-spousal beneficiary who is less than ten years younger than the original account owner.
  • Those who are disabled or chronically ill as defined by the IRS rules.

The rule changes for inherited IRAs will profoundly impact the estate planning of some account holders because these new rules may drastically increase the tax paid by many account beneficiaries. Here's a further look at the RMD rules for various types of beneficiaries:

RMD rules when a spouse inherits a Traditional IRA

When a spouse inherits a traditional IRA from their spouse, they can treat the account as their own. In this case, the spouse would take RMDs from the account based on their own age. They can also roll it into another traditional IRA or other taxable accounts.

Another option is they can treat themselves as the beneficiary of the account. This could be advantageous when the surviving spouse is either under the age of 59½ or older than the deceased spouse.

In this case, if your spouse died prior to the date of commencing their RMDs, this option offers the ability to take withdrawals with no penalty if you are under the age of 59½.

But if you are older than your deceased spouse, you can defer RMDs until they would have reached age 72. This provides a later date than if you had to take them based on your age.

RMD rules when a spouse inherits a Roth IRA

In a Roth IRA case, the money inherited from their spouse can be treated as their own Roth IRA account with no required distributions.

RMD rules when a non-spouse inherits a Traditional IRA

For traditional IRAs inherited by non-spousal beneficiaries prior to January 1, 2020, the option to stretch the IRA by taking RMDs remains intact. You can't treat it as your own, but you can make what is called trustee-to-trustee transfers. Under this process, the beneficiary takes RMDs based upon their life expectancy. If they are younger than the original account owner, this can result in smaller RMDs and allow them to stretch the inherited IRA for a number of years.

For traditional IRAs inherited on or after January 1, 2020, the new rules outlined above under the SECURE Act will apply.

RMD rules when a non-spouse inherits a Roth IRA

For Roth IRAs inherited by a non-spousal beneficiary prior to January 1, 2020, they had the option to open an inherited IRA account and take RMDs over their life expectancy. If the five-year rule on the Roth IRA had been met by the account owner and they were at least age 59½, the RMDs would not be subject to tax.

For Roth IRAs inherited on or after January 1, 2020, the SECURE Act's rules outlined above apply. This means that most non-spousal beneficiaries must take a full distribution from the account within five years. Qualified withdrawals will be tax-free for the beneficiary.

Required minimum distributions rules when inheriting a 401(k)

If the beneficiary of the account is a spouse, they will generally be able to roll the amount in the account to their own traditional or Roth IRA and treat it as their own. The IRS rules allow a traditional IRA to be converted to a Roth IRA.

Spouses under age 59½ may want to be treated as an account beneficiary as in the example above.

In general, since designated Roth 401(k) accounts are subject to RMDs, it generally makes sense to roll them over to a Roth IRA to avoid making withdrawals.

For non-spousal beneficiaries who inherit a 401(k) on or after January 1, 2020, the rules under the SECURE Act outlined above apply.

RMD rules when an entity inherits an IRA

When a trust, charity, or other entity inherits, the applicable rules are complex and became even more complex under the SECURE Act. It's best to seek a financial advisor's advice in this area to determine if RMDs apply to the situation. You can use a service like Paladin Registry to find the right advisor for you.

How to avoid RMDs

There are several tactics and methods to avoid or reduce the amount of RMDs.

1. Designated Roth 401(k) accounts

For those who have money in a designated Roth 401(k) account, if they've left their employer, they can roll the balance over to a Roth IRA. Roth 401(k)s require RMDs; Roth IRAs do not. The reason to consider this is to allow the funds to continue to grow tax-free in the Roth IRA versus withdrawing funds from the Roth 401(k) as required.

2. Roth IRA conversions

Converting money in a traditional IRA account to a Roth IRA eliminates future RMDs on that money. Note that tax will be due on the amount converted in the year of the conversion.

3. Withdrawal of Funds

Withdrawing money from a retirement account reduces the number of future RMDs. Tax will still be due on these withdrawals. This could make sense for some account holders if their income is low in the years before the commencement of their RMDs.

4. Qualified charitable distributions (QCDs)

QCDs are amounts of money donated to charity from the IRA account holder's RMD in a given year. Due to a quirk in the SECURE Act, the qualifying age for QCDs remains at 70½.

Account-holders are allowed to divert up to $100,000 of their RMD amount to qualified charities. Any amounts donated via a QCD are not subject to tax. The QCD doesn't reduce the RMD per se, but it does mitigate taxes.

Note there is no charitable deduction available for amounts given via a QCD.

5. 401(k) when still working at age 72 and beyond

If you are still employed at age 72 and do not hold a 5% or greater ownership stake in the company, you can defer RMDs on the money in your 401(k) account at that company. The company must adopt this exemption in order for this to apply. This deferral does not apply to RMDs on any other retirement account.

A strategy to consider is a reverse rollover of a traditional IRA or an old 401(k) from a different company into your present company's plan if it accepts these types of transfers. This money will then also be eligible for the deferral of RMDs.

Make sure you know your RMD

Required minimum distributions remain a factor to be considered in connection with retirement accounts. Depending upon a person's situation, RMDs can impact the order in which withdrawals are made — from retirement accounts vs. from taxable accounts. It can also make Roth conversions an attractive option for some.

The SECURE Act made some major changes in the rules for inherited IRAs. These rules may cause some people to rethink their estate planning strategies to avoid the pitfalls of the new rules for non-spousal beneficiaries.

Understanding the impact of required minimum distributions is an important aspect of your tax planning strategy in retirement.

Roger Wohlner Freelance Contributor

Roger Wohlner is an experienced financial advisor, finance blogger and freelance writer based in Arlington Heights, Ill. His expertise includes providing financial planning and investment advice to individual clients, 401(k) plan sponsors, foundations and endowments.


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