"RMD." What do those three letters mean to you? If you're in your seventies, they mean a lot. "RMD" is an abbreviation for "required minimum distribution." This is the amount of money that retirees age 70½ and older are required to withdraw from tax-deferred plans such as IRAs and 401(k)s.
RMD rules are serious business. If you don't understand the tax law regarding calculating required minimum withdrawals, you might want to consult an accountant or other professional tax advisor. The penalty for not withdrawing the proper amount is 50% of the amount that should have been withdrawn, but wasn't.
The only exception to the RMD beginning age of 70½ is for workers who are still working for the company where they have a retirement savings account (e.g., 401(k) or 403(b) plan). They can delay their beginning withdrawal date until April 1 of the year following the year that they retire. This is called the "still working exception."
For all others, the first RMD can be taken as late as April 1 of the year following the year that someone turns 70½. For example, if you turned 70 on November 1, 2003 and 70½ on May 1, 2004, you must take your first RMD no later than April 1, 2005.
If you postpone your initial RMD until the following year, however, you will have to take two distributions during that first year. Therefore, for most people (unless you expect a big drop in income), it is preferable to take the first RMD at age 70½ so that their withdrawals are spread over two tax years rather than being bunched up into one.
How do you determine your RMD so you are sure to withdraw enough money to comply with IRS rules? Fortunately, RMD rules have been greatly simplified in recent years. Follow these five steps described by tax expert Ed Slott in the March 2004 issue of Financial Planning magazine:
Determine the distribution year. The account balance used to compute the RMD is based on the balance in a person's retirement account on December 31 of the previous year.
Calculate the account balance. Begin with the balances in all retirement accounts. An exception is Roth IRAs, where withdrawals are tax-free if an account has been open for at least 5 years.
Look up the life expectancy factor on which RMDs are based. A copy of the IRS Retirement Plan Uniform Distribution Table can be found in the "Resources" section of the Rutgers Cooperative Extension Web site, www.rce.rutgers.edu/money2000.
Divide the account balance by the life expectancy factor. An example is that the life expectancy factor for a 70-year-old is 27.4. If a retiree has a $100,000 IRA balance the previous December 31, the RMD would be $3,649.64 ($100,000 divided by 27.4). A separate table is used for married couples with more than a 10-year age difference between spouses.
Take the RMD. Retirees must make their RMD withdrawal by the end of the distribution year. If they have multiple IRAs, they must aggregate the balances in each. The actual withdrawal can come from any one, or a combination, of their accounts as long as at least the required minimum amount is taken.
One final note: this article has been about required minimum distributions. Retirees can always withdraw more. After age 59½, retirement plan owners can withdraw as much money as they want from tax-deferred accounts without penalty. Taxes are due on the withdrawn amount, however, so advance planning, perhaps with a professional tax advisor, is in order.