No matter how far or near you are to retirement, you probably know it’s important to be putting something away for your future self.
Something we don’t talk as much about is taking your money out when retirement comes.
Many people know you have to wait until a certain age to withdraw without penalty, but what you may not know is that there are penalties if you don’t withdraw by a certain age.
The government provides tax protection over your retirement accounts for what it considers your working years, but it doesn’t want to miss out on its cut forever. That’s why most retirement accounts have required minimum distributions, or RMDs for short.
An RMD is the minimum amount you are required to withdraw from your retirement account each year after you turn 70 and a half. You get the withdrawal, and Uncle Sam gets income tax on it.
6 Things You Need to Know About Required Minimum Distributions
RMDs aren’t inherently bad. Most of us want to use the money we spent years waiting for, and there’s no avoiding taxes on most accounts. But there are some important things you should know about them that will help you prioritize how you save now and how you withdraw later.
Laura Adams, host of the “Money Girl” podcast, told us the six rules every investor should know about RMDs on her Aug. 15 episode.
1. All Retirement Accounts Have RMDs… Except One
All tax-deferred retirement accounts, except for the Roth IRA, have RMDs. That means any retirement plan — whether individual or from an employer. Even a Roth 401(k) and Roth 403(b) are subject to minimum distributions once you’re 70 and a half.
That makes the Roth IRA a great tool for young investors, because you can let the money grow tax-free for the rest of your life.
2. Some Retirement Plans Have Exceptions
If you’re not sure how much to save for retirement, you’re likely to undersave. That means you could need to work beyond age 70 and a half.
If that’s you, as long as you’re working for an employer with a retirement plan such as a 401(k) or 403(b) that you’re contributing to, you can defer RMDs on that account. That would be a good reason to roll over any 401(k)s from past employers into your current 401(k).
3. Your RMD Amount Will Change Every Year
The amount you’re required to withdraw depends on a few variables, including how much is in your account and your life expectancy. It’s necessary to use an online calculator to get a clear prediction of yours.
Because these variables change every year, so does your RMD. Distribution requirements typically move on a bell curve, increasing for the predicted first half of your retirement and decreasing in the second. You can always withdraw beyond your RMD, but unfortunately, you can’t credit the excess toward the next year’s requirements.
4. Different Accounts Can be Subject to Different RMD Rules
If you have multiple retirement accounts, each will have its own RMD rules, so it’s important to calculate them separately.
RMDs from multiple IRAs can be combined for an aggregate RMD. However, if you have separate 401(k)s, you’ll need to withdraw separately for each one — again, a great reason to roll over your 401(k) to your current employer’s or a traditional IRA whenever you leave a job.
5. Rollovers Can Protect You From Some RMDs
While both the Roth 401(k) and Roth 403(b) are subject to RMDs, you can roll them into a Roth IRA tax-free.
You can also do a Roth IRA conversion from your traditional IRA. It preserves money you want to keep invested in the market, which is especially good if your retirement savings are low. But remember, you’ll pay tax on the conversion, so this might not be the best option if you’re in a high tax bracket.
6. There Are Fees For Not Complying
Depending on when your birthday is, your first RMD must be taken by Dec. 31 of the year you turn 70 and a half, or by April 1 of the following year. If you forget or decide you don’t want to comply, you’ll be charged income tax and a penalty equal to 50% of your unwithdrawn RMD.
This article contains general information and explains options you may have, but it is not intended to be investment advice or a personal recommendation. We can’t personalize articles for our readers, so your situation may vary from the one discussed here. Please seek a licensed professional for tax advice, legal advice, financial planning advice or investment advice.
Jen Smith is a staff writer at The Penny Hoarder. She gives money-saving and debt-payoff tips on Instagram at @savingwithspunk.
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