An important part of retirement planning is anticipating and managing required minimum distributions (RMDs)—the money you must withdraw from IRAs and most types of defined contribution plan accounts.
Understanding which accounts are subject to RMDs, tax implications, and how much you must withdraw is the first step toward developing a withdrawal strategy that will help maximize the money you will have available in retirement.
When you reach age 72, you must start taking withdrawals, known as required minimum distributions (RMDs), from most traditional and Roth retirement accounts; the exception is the Roth individual retirement account (IRA). RMDs can have a significant impact on retirement planning and should be considered when choosing the type(s) of retirement accounts you invest in, as well as how and when you withdraw assets from them (Table 1).
Table 1: RMD and Account Type
|Account Type||RMD Required||RMD Included In Taxable Income||Other Features|
|Traditional IRA||Yes||Yes||- QCD option
- Can aggregate RMD amounts with other traditional IRAs
|Roth 401(k)||Yes||No||- Can roll over to a Roth IRA and avoid RMD|
- Can aggregate RMD amounts with other 403(b) accounts, including Roth 403(b) accounts (except inherited 403(b) accounts)
- Can roll over to a Roth IRA and avoid RMD
Pretax contributions and earnings withdrawn from traditional accounts are subject to federal income tax. State income tax might also apply. This does not apply to qualified distributions from Roth retirement accounts or Roth IRAs. In addition, taxable withdrawals affect other tax-related items, such as the amount of future Medicare premiums as well as taxation of Social Security benefits.
How Much You Must Withdraw
Your RMD is determined each year by a formula based on your age and your account balance at the end of the previous year. The IRS publishes life expectancy tables for this calculation. For most individuals, the first year’s RMD is typically 3.6496% (1/27.4) of the prior year’s balance. That percentage increases each subsequent year as the remaining distribution period declines. For example, a person who is 72 years old with a traditional IRA that had a balance of $1 million at the end of last year would typically have a $36,496 RMD, which is $1 million divided by 27.4. That same $1 million account balance for a person who is 73 would require a minimum distribution of $37,736. You may take your RMD amount as one lump sum at any point during the year or as multiple withdrawals throughout the year, as long as the total withdrawn by the end of the year is at least the required amount. You are always allowed to withdraw more than the RMD amount.
Sally turns 72 this year and has two traditional 401(k) plan accounts with balances of $100,000 and $200,000 at the end of last year. Sally also has two traditional IRAs which had balances at the end of last year of $300,000 and $400,000. The RMDs for the accounts are $3,650, $7,299, $10,949 and $14,599, respectively.
To receive no more than her 2022 RMD, Sally must take exactly $3,650 from her first traditional 401(k) and exactly $7,299 from her second traditional 401(k).
For the traditional IRAs, Sally can aggregate the RMD amounts and take the $25,547 from either or both of the traditional IRA accounts as she determines. For example, Sally could take the full amount from just one account or some from each account (so long as she takes the full amount).
Rules Differ by Account Type
You must calculate the RMD for each traditional IRA you own. If you have more than one traditional IRA, you can aggregate your total RMD amount and withdraw that from any one account or any combination of accounts. One unique feature of a traditional IRA RMD is that up to $100,000 per year can be directed to a qualified charity in a qualified charitable distribution (QCD). The amount of a QCD is not included in your gross income, which could provide positive tax and financial benefits.
Roth IRAs are not required to make lifetime RMDs.
Traditional and Roth 401(k)s
For traditional and Roth 401(k) plan accounts, you must take your RMD from each account individually. You cannot aggregate the withdrawal amounts as you can with traditional IRAs.
Traditional and Roth 403(b)s
You must calculate the RMD for each 403(b) account you own. If you have more than one 403(b), you can aggregate what your total withdrawal amount needs to be from all your accounts and distribute that amount from any one account or any combination of accounts.
For example, you may take your traditional 403(b) account RMD from your Roth 403(b) or vice-versa. While Roth 401(k)s/403(b)s are subject to RMDs, once you leave your employer, you may roll your account balance into a Roth IRA, which does not require lifetime RMDs. If you fail to take your RMD, you are subject to a federal tax penalty equal to 50% of the RMD that should have been distributed.
When Withdrawals Begin
You may take your first RMD by December 31 in the year you reach age 72, or you can defer it until April 1 of the following year.
After the first year, you must take each year’s RMD by December 31. If you defer the first year, you will need to take the first two years’ RMDs in the second year.
If you are still employed when you attain age 72 (70 ½ if you were born before July 1, 1949) and your current employer’s plan allows for it, you may delay your RMD for that account until April 1 of the year following your retirement. This exception does not apply if you own 5% or more of the business sponsoring the plan.
For more information, please contact your PNC Private Bank advisor.