Year after year of hard work always pays off in retirement. Nowadays, saving during this golden age has practically become a priority in the lives of our retirees (and in the lives of workers as well). It is clear that we all dream of a future where we can enjoy what we have earned with the sweat of our brow, but, once the time comes, there are rules that perhaps we did not expect or did not know in full. One of these rules is the one known as Required Minimum Distributions (RMD). Rules like this one may seem like an obstacle, but are there to protect your savings! If you are almost ready to retire, or are already enjoying it, in this article we are going to explain how to understand RMDs and how to manage them to make the most of them!
What are Required Minimum Distributions (RMD)?
Imagine you have a jar full of candy that you’ve been saving for years, but someone tells you that you need to empty those candies from time to time. Basically, RMDs are the minimum amounts you must withdraw from your retirement accounts each year once you turn 73 (for example, if you were born in 1951, the deadline to make your first withdrawal is April 1, 2025, run!!)
Even if you don’t need the money, you’re required by law to make these withdrawals, it is better to take the money out than get fined!
How do I know how much to withdraw?
The IRS uses a formula that is based, first, on your total account balance at the end of the previous year, and second, on your life expectancy according to specific IRS tables. Thus, the younger you are when calculating the RMD, the lower the percentage you have to withdraw.
Let’s say you have an IRA account with a total balance of $500,000 at the end of the previous year. According to the IRS life expectancy tables, if you are 73 years old, your estimated life expectancy is 26.5 years.
The amount you need to withdraw is calculated by dividing your account balance by your life expectancy.
- Formula: RMD = Total account balance ÷ Life expectancy
- Applying the data:
- RMD = $500,000 ÷ 26.5
- RMD = $18,867.92
In this case, you would need to withdraw at least $18,867.92 from your account during the year to comply with IRS rules, easy, right?
Who does this rule affect?
RMDs apply to most retirement accounts, such as:
- Traditional IRAs.
- SEP IRAs or SIMPLE IRAs.
- Employer-sponsored retirement plans such as a 401(k), Roth 401(k), 403(b) or 457(b).
There are important exceptions, though:
- If you’re still working and have an employer-sponsored retirement plan, you can postpone RMDs until you retire unless you own more than 5% of the company.
- Beginning in 2024, Roth accounts within a 401(k) or 403(b) will be exempt from RMDs while the owner is alive.
Are there any consequences if I don’t do it?
Keep in mind that that RMD amount will directly affect your tax return because it is a taxable income. So, you have to be aware that you have to do the math every year, since your balance will change as much as your life expectancy.
In case you don’t withdraw the money, the IRS could fine you with a penalty of up to 50% of the amount not withdrawn, so, since we don’t want anything else to affect our retirement plans, it is essential that you consult with an advisor or check the IRS official website for more information on this matter.
Remember that the purpose of this measure is to protect your retirement money, so it would be best to start heading to the ATM now so that you don’t miss the deadline!