RMDs: How they impact withdrawing from retirement accounts

Now that you’re nearing retirement or have reached your golden years, it may be time to shift your attention from how to save more to how to properly withdraw the savings from your accounts.

Learn about Required Minimum Distributions (RMDs), from what they are to tax tips that help you get the most out of your withdrawals.

What is a Required Minimum Distribution?

A Required Minimum Distribution refers to the minimum amount you must withdraw on an annual basis from your retirement plan. They apply to all employer-sponsored retirement plans — 401(k)s, 403(b)s, 457(b)s, etc. — as well as Traditional Individual Retirement Accounts (IRAs), IRA-based plans (SEPs, SARSEPs, SIMPLE IRAs), and Roth 401(k) accounts. RMDs do not apply to Roth IRAs (until after the death of the account owner) or non-retirement accounts.

Generally speaking, you are required to begin receiving RMDs by age 72. On the flip side, you can begin making tax-penalty-free withdrawals from your retirement accounts at age 59 ½.

How is your RMD calculated?

According to the IRS, your RMD is calculated for each retirement account by taking the balance of the account as of December 31 of the year prior to you turning 72 and dividing that number by a life expectancy factor. Note: You must recalculate your RMD each year based off your balance from December 31 of the previous year.

There are a number of factors taken into account when calculating your RMD, such as the age of your spouse. You can learn more about life expectancy factors via tables found in the IRS publication, “Distributions from Individual Retirement Arrangements.”

When are your RMDs due?

As mentioned above, you are required to start withdrawing from your retirement accounts at 72. That means that you must take your first payment by December 31 of the year in which you turn 72.

However, you can delay your first payment — and only your first payment — until April 1 of the year after you turn 72. If you wait to delay your first RMD, you must still make your second RMD withdrawal by December 31 of that same year. For example, if you turn 72 in May 2017, your first RMD is due by December 31, 2017. If you choose to delay your first RMD, it must be withdrawn by April 1, 2018. Then, your second RMD would be due by December 31, 2018. Note: Making multiple withdrawals in a year has tax implications (more on that later).

Do you have to withdraw RMDs if you're still working at 72?

It depends. If the account is an IRA, then you must begin making RMDs at 72, regardless of whether you’re still employed or not. If it’s a 401(k) or other company plan, you might be able to delay withdrawing your RMDs due to the “still working” exception.

You can qualify for the “still working” exception if:

1. You are employed throughout the year you turn 72
2. You own no more than 5% of the company that sponsors the retirement plan
3. The company retirement plan allows you to delay withdrawing RMDs

What if you don't withdraw your full RMD in time?

In addition to paying the tax penalty, you’ll also have to file Form 5329 (used if you owe the IRS any retirement plan penalties) with your federal tax return for that year.

According to the IRS, the tax penalty can be waived if your reason for not withdrawing the full RMD was a result of a “reasonable error” and reasonable steps are being taken to remedy the shortfall. However, you’ll still have to file Form 5329 and attach a letter that explains why the full amount was not withdrawn.

What happens if the account owner dies before their RMDs begin?

In this case, the entire benefits of the retirement account are distributed to the beneficiary in one of two timelines:

1. Within five years of the account owner’s death, or
2. Over the life of the beneficiary starting no later than one year after the account owner’s death

Note: Roth IRAs do require RMDs after the death of the account owner.

Tax considerations for RMDs

Withdrawals from retirement accounts (not including Roth IRAs) are taxed as ordinary income based on your tax bracket.

U.S. News recommends these options to limit the taxes you’ll pay on your withdrawals:

1. Don’t withdraw too early: Withdrawing funds from your retirement accounts before 59 ½ will result in a 10% penalty tax, not to mention the income tax you’ll already be paying on the withdrawals. There are exceptions when you would not have to pay the 10% penalty tax (ex. if the account owner dies before they begin withdrawing RMDs).
2. Start withdrawing RMDs before 72: Spreading your RMDs over a longer period of time (ex. starting at age 67 instead of 72) could help spread the tax bill and help you stay in a lower tax bracket.
3. Donate your RMDs: You can avoid income taxes paid on withdrawals if it goes directly to a qualified charity. Doing so counts as your RMD for that year.
4. Limit your withdrawals to one per year: Delaying your first RMD until April 1 of the following year does not absolve you from making your second RMD by December 1 of that same year. You could face a higher tax bill or be bumped into a higher tax bracket if you take two RMDs in the same year.

While there are some tactics that can limit your tax payments on your RMDs, it’s important to note that RMDs cannot be rolled over into another tax-deferred retirement account. Also, remember that these tax tips do not apply to Roth IRAs since contributions are made after taxes and therefore the withdrawals are not taxed.

You should always understand the tax consequences of a withdrawal before initiating one, so consult a tax advisor about your situation.

More information

There is much to know about how to withdraw from your retirement accounts. To learn what plan best fits your needs, schedule a Citizens Retirement Checkup at your nearest Citizens branch.