Mandatory Minimum Distributions (MMDs) or simply put, the necessary yearly withdrawals from retirement accounts as dictated by the law.

Mandatory Distributions of Minimum Required Assets (MDMRA)

Required minimum withdrawals, or RMDs, are compulsory withdrawals from pre-tax retirement savings accounts like 401(k)s and IRAs.

Money deposited into these pre-tax retirement accounts could have been saved decades ago, meaning it hasn't been taxed during that period.

RMDs were implemented to guarantee that the Internal Revenue Service (IRS) collects the tax revenue related to retirement savings before the account holder's demise. Consequently, RMDs are calculated between a retiree's early 70s and their predicted lifespan remaining.

Here, we will briefly explain what an RMD is, the accounts requiring an RMD, perform a simple RMD calculation, and consider how RMDs impact annual tax returns.

What is an RMD?

RMDs are mandatory withdrawals from retirement accounts that take effect post-retirement for most individuals.

You'll be required to take your first RMDs from any pre-tax retirement accounts by April 1 of the year following your 73rd birthday (previously, RMDs started the year after turning 72). Subsequent RMDs must be withdrawn by December 31 each year.

For example, if you turned 73 in 2024, you'd need to take your first RMD by April 1, 2025, and your next RMD by December 31, 2025. Subsequent RMD deadlines will be December 31.

Under the Secure Act 2.0 rules, the RMD age will increase to 75 in 2033.

The amount you must withdraw from your account, subject to taxation as ordinary income, is determined by your life expectancy. You can calculate your annual RMD using the account balance at the end of the previous calendar year from the IRS table.

Several factors can affect the IRS table used for calculating RMDs, so ensure you are using the most recent table before making any withdrawals.

RMDs by account

While not an exhaustive list, these are some of the more common accounts mandating RMDs:

401(k)s or 403(b)s: If you have a pre-tax retirement account, you'll be required to withdraw a certain percentage annually from your employer-sponsored plan after your 73rd birthday. (The Secure Act increased the RMD age from 70 1/2 to 72, and the Secure Act 2.0 increased it again to 73 in late 2022.) Roth-designated accounts no longer have RMD rules as of 2024.
Inherited IRAs: Pre-tax retirement accounts passed down from deceased relatives are also subject to required annual distributions. You will likely roll the account into an inherited IRA, which has complex rules for distribution based on your relationship with the original account holder. The administration of inherited IRAs has become increasingly intricate following the Secure Act. Consult a qualified tax advisor to navigate your specific situation.
Traditional IRAs: Traditional IRAs are also subject to RMDs once you reach 73. (We are referring to IRA accounts with pre-tax balances or untaxed money.) Roth IRAs, which have already been taxed, do not have RMDs.

For certain accounts, such as IRAs, your total RMD amount is the aggregate of all RMDs for all pre-tax retirement accounts. You can withdraw the entire amount from a single account, although this might be challenging to manage if your accounts are spread across multiple brokerages.

For inherited IRAs, this is permissible as long as you have inherited the IRA from the same individual.

Calculating your RMD

If you've saved $200,000 for retirement in an employer-sponsored plan like a 401(k) and turn 73 in 2024:

For your first RMD, you have until April 1, 2025, to take out the calculated amount from your account without incurring penalties.

Every subsequent RMD must be withdrawn by December 31 of the year in question. For example, you'd need to take your second RMD by December 31, 2025.

To calculate your first RMD, you'd divide $200,000 by your distribution factor (or life expectancy, as calculated by the IRS) of 16.4, yielding a first RMD of $12,195. By April 1, 2025, you must withdraw at least $12,195 from your retirement account.

To calculate your second RMD in 2025, divide your 2024 end-of-year account balance by your distribution factor at age 74, which is 15.6.

Remember, even if you choose to take your first RMD on April 1, 2025, you'll still need to take your second RMD by December 31, 2025.

It's possible to withdraw two RMDs in the year following your 73rd birthday, and you should consider personal factors, including your total income for both years.

There isn't any special tax exemption for required minimum distributions (RMDs) – unlike with dividends or capital gains – so you need to be extra cautious when planning your finances around RMDs.

Taking the minimum distribution is mandatory, but going beyond it can be beneficial if you're having a low-income year. By deliberately liquidating substantial portions of your pre-tax retirement savings, you can reduce your tax liability if your total income isn't sufficient to fill lower tax brackets.

However, if you're a high-income earner, taking more than the required minimum distribution can push you into a higher tax bracket, which results in higher tax payments. Excessive retirement income can also lead to increased Social Security taxation and Medicare premiums.

Penalties for RMDs

Neglecting to take your RMD on time attracts a 25% penalty. If you correct your error within the stipulated time, the penalty reduces to 10%. This penalty is in addition to the taxes you owe on the missed RMD, and depending on your overall tax situation, you may also need to pay interest. Consequences of not taking your RMD can be severe.

For instance, failing to withdraw $12,195 in the first year you were responsible for RMDs could result in a penalty of up to $3,048.

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Managing RMDs

Though RMDs are inevitable, careful tax projections can help you make an informed decision about withdrawing more than the minimum distribution if it's beneficial in your current tax situation, or if it's better to stick to the minimum distribution.

Regardless, make sure to take your RMDs on time to avoid costly penalties that can erode a portion of your retirement savings. Considering your entire financial picture before making a decision related to RMDs is essential, as it's rarely wise to focus on a single account in isolation. Spending some time to educate yourself about RMDs can provide you with a comprehensive understanding of how to work with them effectively in the future.

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The Internal Revenue Service (IRS) implements RMDs to collect tax revenue related to retirement savings before an account holder's demise, ensuring the RMD amount is determined by the individual's life expectancy. This compulsory withdrawal from pre-tax retirement accounts like 401(k)s and IRAs can significantly impact one's annual tax returns.

Following this text, two additional sentences could be:

To effectively manage your finances during retirement, it's crucial to consider how RMDs will impact your overall financial strategy, including income, investments, and potential tax implications.

When it comes to retirement, understanding the implications of RMDs is essential for maintaining financial stability and ensuring a comfortable retirement.