The day you turn 72 may not be marked with fun emojis on your calendar, but the IRS certainly has that birthday in its sights. That’s because at age 72, the IRS requires you to begin taking RMDs from your 401(k), IRA or other tax-deferred retirement plan(s). An RMD, or required minimum distribution, is the minimum amount of money that you are required, by law, to withdraw each year from employer-sponsored retirement plans and Individual Retirement Accounts (IRAs), starting at age 72. Miss the annual RMD deadline and you could face a stiff penalty of up to 50 percent of the amount you should have withdrawn.
If you’re going to be subject to RMDs in the coming years, it’s a good idea to familiarize yourself with the rules to avoid common RMD pitfalls. Patrick Horning, senior director of advanced planning for Northwestern Mutual, offers five things to know about RMDs.
Make sure you take your RMD on time
Your first RMD will be for the year in which you turn 72.
“The IRS gives you a little leeway for the timing of your distribution, but only for your first RMD,” says Horning. “You actually have until April 1 of the calendar year following the one in which you turn 72 to take your first distribution. After that, your annual RMDs must be taken no later than Dec. 31 of the appropriate year.”
Just because you can delay your RMD doesn’t mean you should
Generally speaking, Horning recommends a quick tax check before postponing your initial RMD.
“Delaying your distribution until April 1 following the year in which you turn 72 means that you’ll need to take your first and second distributions in the same calendar year. This could bump you into a higher tax bracket; it could also make you subject to the Medicare high-income surcharge. This applies if your 2023 adjusted gross income (plus tax-exempt interest income) exceeds $97,000 if you are single or $194,000 if you are married and file jointly. The extra income also may also mean that a larger portion of your Social Security benefits will be subject to taxes."
Calculating your RMD is easier than you might think
Your RMD amount for any given year is determined by a relatively simple calculation that involves dividing your retirement account balance(s) as of Dec. 31 of the prior year by a life expectancy factor (based on your age) that is set by the IRS. The IRS publishes tables and worksheets to guide you through the calculation.
If you have multiple IRAs (Traditional, SEP, and SIMPLE IRAs), you will need to calculate the RMD for each account separately but you can aggregate the amounts and withdraw your RMDs from any one (or more) of your IRAs. If you have more than one 401(k) or other employer-sponsored retirement plan accounts, the RMDs must be taken out of each account separately. No RMDs are required for Roth IRAs since you funded those accounts with after-tax dollars. However, once you die, your Roth IRA beneficiary(ies) will be required to take distributions. Their distribution options will vary depending upon whether your beneficiary is your spouse, another loved one, or a trust or estate. You do have to take RMDs from your Roth 401(k), but you can avoid this by rolling those funds into a Roth IRA.
Do you have to take an RMD if you’re still working?
If you are still working at age 72 and participate in your employer-sponsored plan, you may be able to postpone taking RMDs from the plan until you retire — unless you own more than 5 percent of the company you work for. IRAs do not have this more than 5 percent owner rule. You can avoid having to take RMDs on IRAs or other 401(k) plans by rolling those assets into your current plan, if possible.
RMD mistakes can be costly
The RMD rules are designed to ensure that the IRS eventually gets to collect taxes on your retirement plan earnings and investment gains. As a result, the penalty for failing to comply with RMD requirements is steep. If you don’t take your distributions on time or you calculate the amount incorrectly, you’ll owe a 50 percent penalty tax on any RMD amounts you should have taken but didn’t. This penalty is in addition to the regular income tax that you will owe for the distribution.
The rules pertaining to RMDs can be complex. For that reason, it’s a good idea to consult with your financial or tax professional for more information.