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What is an RMD?

April 06, 2022

What is an RMD?

Financial planning is essential to make the most out of your retirement. Within the financial world, it is important to pay attention to all the rules and laws that may apply to the different retirement accounts that you have. One of the most important rules to understand is the Required Minimum Distribution (RMD) that will apply to any funds you may have in employer-sponsored retirement plans.

What is a Required Minimum Distribution?

An RMD is the minimum amount of money that you must withdraw from defined benefit retirement accounts. This minimum amount is subject to ordinary income tax when it is distributed from the account. While the threshold for Required Minimum Distributions used to be from the age of 70 ½, new legislation has since increased this threshold to 72.

What is qualified money?

When talking about RMDs, it is important to understand what accounts and funds are subject to these minimum withdrawal rules. Required Minimum Distribution (RMD) laws apply to all ‘qualified money.’ This term refers to all funds that are in employer-sponsored retirement plans such as profit-sharing agreements, 401(k) plans, 403(b) plans, traditional IRAs, SEPs, SARSEPs, and SIMPLE IRAs. Qualified money is also known as ‘pre-tax dollars’. It is important to note that these withdrawals do apply to Roth 401(k) accounts but do not apply to Roth IRA accounts

The older you get, the more they take

The Required Minimum Distribution (RMD) for your qualified money increases as you get older. While this isn’t a fixed percentage of your funds, the IRS releases a Uniform Lifetime Table that is used to calculate the minimum distribution that you will be required to withdraw from your retirement accounts.

To calculate what your RMD would be, simply take the balance within your account from the end of previous year and divide it by the Life Expectancy Factor that is supplied by the IRS. For example, if you have $100,000 as your 401(k) balance, you will need to divide this amount by your Life Expectancy Factor for whatever age you are. According to the latest mortality table from the IRS, the Life Expectancy Factor at the age of 72 is 25.6. This means you will divide the account balance of $100,000 by 25.6 to give you a Required Minimum Distribution of $3,906.25 for that year.

What the Secure Act 2.0 means for your RMDs

The Required Minimum Distribution for all qualified money used to kick in once you turn 70 ½ years old. However, due to new legislation that has come into effect in December 2019, this threshold has been lifted to 72. There are talks now of a bill being passed that could increase the RMD age gradually over the course of the next couple of years to age 75. This may seem like a good thing on the surface, but with accounts growing for a longer period of time, and individuals having to take withdrawals out at a higher Life Expectancy Factor, this could potentially lead to much higher taxes once RMDs start to be drawn out.   

The benefits of a Roth IRA

As mentioned above, the Required Minimum Distribution applies to all employer-sponsored retirement plans. However, these RMD rules do not apply to Roth IRAs. You could leave the money in your account until the age of 100, and under current rules, would not have to take a single penny out of the account. This is a reason a lot of individuals will start to explore the idea of a ROTH conversion. (see previous blog about ROTH conversions)

What does this mean for my retirement accounts?

While RMD’s don’t take place until later in your life, that doesn’t mean you have to wait until then to plan for them. Proper income planning is a big factor for a successful retirement. This can sometimes be even more difficult than saving for retirement as the future is so uncertain with not only an induvial’ s personal life, but the laws that Congress and government may change along the way. Take steps early to have the income conversation for retirement and work with an advisor to adjust overtime as goals and laws change.