Seventy-three might not seem like a major milestone birthday, but it is, as far as the IRS is concerned. That’s because once you turn 73, all your tax-deferred retirement accounts become subject to a required minimum distribution (RMD) — and what you might not know about these retirement saving withdrawals can cost you a lot of money come tax time. In this article, we’ll give an overview of what required minimum distributions are, when they start, which accounts are affected, and the consequences of missing them.
Required minimum distribution (RMD) definition
A required minimum distribution is the lowest amount of money you must withdraw from tax-deferred retirement accounts each year once you reach a certain age (currently 73). Although you’re free to take out more than your annual RMD, not withdrawing enough could lead to penalties. Next, let’s look into the reason required minimum distributions are mandated.
Why are required minimum distributions imposed?
To better understand why RMDs exist, it’s helpful to consider the IRS’s reasoning behind imposing them in the first place.
From a bird’s-eye view, the government needs “taxable events” to occur in order to generate revenue. Taxable events are transactions that trigger the generation and subsequent collection of taxes. For example, when you sell a car, the sale itself is the taxable event, and taxes are owed on that transaction.
When you contribute to a 401(k), a 403(b), or other types of tax-deferred retirement accounts, your contributions are deducted from your pretax income. After the deduction, the remaining income is taxed, and the rest is your take-home pay. In other words, the contributions to many types of retirement accounts are made before the taxation event occurs.
Over time, those contributions accumulate. The funds in these accounts are generally invested in equities or bonds by plan administrators, allowing them to grow beyond your initial contributions. However, the money in these accounts, including any growth and returns from investments, has never been taxed.
That’s where required minimum distributions (RMDs) come in: For these accounts, withdrawals are the taxation event and are taxed as regular income. For this reason, the IRS essentially forces a schedule of taxable withdrawals once you reach RMD age.
In contrast, contributions to a Roth IRA are made with money that has already been taxed, meaning the taxation event has already occurred. As a result, the IRS has no claim on Roth IRA withdrawals, so Roth IRAs are exempt from RMDs.
Types of accounts that are subject to RMDs
Some examples of accounts for which a required minimum distribution is applicable include:
- Traditional IRAs (non-Roth).
- 401(k)s.
- 403(b)s.
- 457(b)s.
- SERPs.
- SARSEPs.
- SIMPLE IRAs.
- Profit-sharing plans.
- Other types of employer-sponsored retirement plans.
A good rule of thumb is that if an account is funded by untaxed dollars, it’s likely subject to required minimum distributions.
When do required minimum distributions start?
Required minimum distributions come into play only when you reach the RMD age, which often differs from the age you retire. For most people, RMDs take effect a few years after retirement.
As of 2023, the RMD age is 73 and will remain there until 2032, per the SECURE 2.0 Act. Prior to the act’s passage in 2022, the RMD age was 72. The SECURE 2.0 Act also scheduled another increase in RMD age for 2033, raising it to 75.
Required minimum distributions begin in the calendar year you reach RMD age (73). The deadline for RMDs is usually December 31, but for the first RMD year only, the IRS allows you to take your first one by April 1 of the following year. For those who turn 73 in 2024, the required minimum distribution for 2024 must be taken by April 1, 2025, if it hasn’t been taken already.
There’s a catch to procrastinating: If you delay your first RMD until the following year, you’ll still need to take a second RMD for the current year. For example, if someone turns 73 in 2024, they can take their 2024 RMD by April 1, 2025, without penalty. However, they’ll still be required to take 2025’s RMD by December 31, 2025.
Since RMD withdrawals are taxed as income, taking two in the same calendar year could push you into a higher tax bracket, resulting in a higher tax rate on the same total withdrawal amount, simply due to timing.
How are required minimum distributions calculated?
RMDs are calculated individually and adjusted each year, often increasing over time.
RMDs are typically calculated by adding the total value of all applicable accounts (i.e., those funded by pretax contributions) and dividing it by the distribution period for your age, as outlined in IRS tables.
Total year-end value of RMD-affected retirement accounts ÷ Distribution period for your age = RMD
For example, someone who turns 75 in 2025 will add up the balances of all their RMD-applicable accounts as of December 31, 2024. Next, they’ll find their distribution period based on their age in the IRS tables and divide the total account balance by that number.
To illustrate: If someone turning 75 in 2025 has a total balance of $500,000 across all RMD-affected retirement accounts, the calculation would be:
$500,000 ÷ 24.6 (IRS distribution period for someone who turns 75 in 2025) = $20,325.20 RMD for 2025
This person’s RMD for 2025 is $20,325.20, meaning they must withdraw at least this amount from their tax-deferred accounts by December 31, 2025.
It’s not uncommon for individuals to have multiple retirement accounts after changing employers without rolling over their 401(k)s or moving between the private and public sectors over the course of their career.
If you have multiple accounts subject to RMDs, the IRS doesn’t necessarily require you to take a separate RMD from each one. Depending on the type of account, as long as you meet the total required amount, how you withdraw the funds and from which account is entirely up to you. You could choose to take the full RMD from a single account or distribute the withdrawals across multiple accounts. As long as you hit your annual aggregate RMD from the relevant accounts, the requirement is satisfied.
For some types of accounts, however, the IRS requires that you take your RMDs separately.
What happens if you don’t take an RMD?
In short, penalties. One way to look at penalties on required minimum distributions is the IRS getting their cut, on schedule, whether through taxes or penalties. It’s better to make the withdrawal to avoid being taxed twice on the same amount.
The penalty for not hitting your annual RMD is 25% of the shortfall. If someone misses their RMD by $4,000 in 2024, a $1,000 penalty would be imposed (25% of $4,000) in addition to the income taxes on whatever amount the account holder withdraws that year.
Though leaving retirement accounts to grow indefinitely may seem appealing, RMDs are a reality. However, they are a good source of income for older adults as the cost of living and the cost of care grow with age. By staying informed about when RMDs begin, how they’re calculated, and the accounts to which they apply, you can ensure that your retirement savings continue to work for you — without running afoul of the IRS. Planning ahead and taking timely action will not only help you avoid pricey penalties but also allow you to make the most of your retirement funds.
