Retirees and Required Minimum Distributions

Here is what retirees need to know about required minimum distributions or (RMD).

Traditional IRAs may allow for tax savings in the year of contribution as well as tax-deferred growth for many years to come. Unfortunately, traditional IRAs are also subject to the rules of required minimum distributions. Required minimum distributions are the IRS’s way of saying you have avoided paying tax for long enough.

Specifically, long enough in the eyes of the IRS is April 1 of the year following the year in which you turn 70.5 years old. This is the date at which your first required minimum distribution must be taken. If it is not, the penalty is punitive: 50% of what should have been distributed.

The First Required Minimum Distribution (RMD)

The first required minimum distribution for an IRA owner is due by April 1 of the year following the year in which you turn 70.5 years old. It is then required that you take a distribution every year.

From a practical standpoint, there is a choice when it comes to your first required minimum distribution:

Option 1 – Wait until April 1 of the year following the year you turn 70.5 to take your first distribution.
Option 2 – Take your first distribution in the year you turn 70.5.

The impact of your first distribution, as well as subsequent distributions, is simple.

If you choose option 1, you will be required to take two distributions in that calendar year, specifically, the one you “delayed” for the year in which you turned 70.5 and the annual distribution required for the new calendar year.

If you choose option 2, you will take one distribution in the year you turn 70.5 and one in the following calendar year (and every subsequent year).

How Much to Take

The amount of your required minimum distribution is based on two criteria: the total amount of your combined IRAs (and other qualified accounts) and your age. Specifically, the value used for calculating your annual RMD is the previous year-end balance.

Using a hypothetical example to illustrate, let’s assume you have a previous year-end balance in your IRA of $1,000,000 and you are 70.5 years old. Based on the RMD table provided by the IRS we can see a distribution factor of 27.4.

To calculate the required minimum distribution amount, we use a simple formula:

Previous Year-End Balance / Distribution Factor = RMD

In this scenario, the math is as follows:

$1,000,000 / 27.4 = $36,394.45

Every subsequent year following age 70, the distribution factor in the table becomes smaller. As the distribution factor becomes smaller, the required minimum distribution becomes larger. For illustrative purposes, let’s assume the above $1,000,000 IRA had an owner who was 80 years old. The distribution factor for an 80-year-old is 18.7.

$1,000,000 / 18.7 = $53,475.94

By age 90, the factor is 11.4, meaning a required minimum distribution for a $1,000,000 IRA would be approaching 10% of the account balance.

$1,000,000 / 11.4 = $87,719.30

The older you are, the more you are required to take, all else being equal.

Burst of Knowledge – For an IRA owner with a spouse who is the sole beneficiary and 10 years younger, you can use the joint life expectancy table for calculating RMDs.

What to Do with an RMD You Don’t Need
For some retirees, the required minimum distribution is often an amount that’s greater than what they need to meet their living expenses. To put it another way, if they had the option, they would likely prefer not to take the RMD.