Understanding Required Minimum Distribution Rules

Man working on financial paperwork

If you have a retirement account such as an IRA or 401k, chances are once you reach 70 1/2 years old, you will be required to take minimum yearly distributions. How much these distributions are, when you have to take them, and whether you meet this requirement depends on several factors.

Who is Required to Take Minimum Distributions?

Because the money you put into your IRA is tax deferred, the IRS requires you to start taking money out of your account once you reach a certain age so they can begin collecting tax on it.

Learn about the benefits of a Self-Directed IRA here.

If you have been contributing to a traditional IRA, you will be required to start taking distributions once you reach 70 ½ years old. You will either need to take your first distribution in the calendar year you reach this age or by April 1st of the following year.

If you choose to take your first payment after December 31st you have to take two distributions your first year, which will cause you to pay higher taxes.

However, it’s important to note that Roth accounts and accounts that are sponsored by a current employer are not subject to Required Minimum Distribution (RMD) unless you own more than 5% of the company.

Typically, you will take these distributions from 401k and IRA accounts that were sponsored by past employers.

How to Calculate your RMD

Each year that you are required to take an RMD, you are assigned a divisor. The first year it is 27.4. This is actually the number of years that, on average, you are expected to live, as the divisor determines how long your distributions should last.

Divisors change each year. For the first five years they are as follows:

  • Age 70 – 27.4
  • Age 71 – 26.5
  • Age 72 – 25.6
  • Age 73 – 24.7
  • Age 74 – 23.8

The first year you are required to take a distribution is considered year one. That means the number 1 will be divided by 27.4, equalling 3.65%. That means you would have to take a distribution of 3.65 percent from your IRA the year you turned seventy.

For example, if you had an IRA with a value of $100,000 in year one, you would be required to take a distribution of $3,650.

In year 2 it would rise to 3.77%, (2 divided by 26.5), and the percentage would continue to go up each additional year. This is meant to time your distributions properly so they last you for the majority of your retirement years.

However, if you are married and your spouse is younger than you by more than ten years and is your only beneficiary, the divisor is larger. That allows you to keep more money in your IRA longer.

How You Receive Your Distributions

You have a few options when it comes to receiving your distribution. You can either take a lump sum payment or have monthly withdrawals.

The lump sum can happen at any time during the year as long as it is before the year ends. You also have the option to have state and/or federal income taxes taken out of your distribution before the money reaches you.

If you have more than one IRA or 401k, you will need to calculate the RMD for each account separately.

If you want to be prepared for your Required Minimum Distribution take a moment to connect with the professionals at BP Financial today.

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