Thanks to the recent increase in contribution limits, plan participants are rewarded for investing in their retirement plan now more than ever. While this is an important part of securing the financial future of employees, it’s equally important to ensure you are making the required minimum distributions. What are required minimum distributions, and why are they important? We answer these questions and more below.
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What are Required Minimum Distributions?
A required minimum distribution (RMD) is a specific amount of money that must be withdrawn from an employer-sponsored plan as well as traditional, SEP, and SIMPLE IRA. This must be done on a yearly basis once you reach retirement age. Although it may seem strange to be required to take money out of an account instead of saving it, these required distributions are meant to deter people from avoiding their taxes; thus, the IRS takes them very seriously. According to Investopedia, avoiding taking out your RMD leads to a penalization where you will be taxed 25% on the amount you’ve failed to withdraw.
The Rules for Required Minimum Distributions
As per the new rules set forth by SECURE Act 2.0, account holders must start taking RMDs once they reach the age of 73 with subsequent RMDs made by the end of each year following. That said, there are a few ways to delay making required minimum distributions.
First, the IRS does recognize that account holders may need a grace period in which they can prepare for their first withdrawal. Therefore, you are allowed to defer your initial required minimum distribution up to April 1st of the year following your 73rd birthday. Second, account owners with a workplace retirement plan can delay taking their RMD until the year they retire. Note that this does not apply to anyone who is a 5% owner of the business sponsoring the plan.
Under SECURE Act 2.0, individuals 73 or older must begin taking RMDs. The age will be raised to 75 in 2033.
How RMDs are Calculated
Even if you do choose to delay your required minimum distributions, it will eventually need to be satisfied. To figure out how much must be withdrawn, you must take the retirement account’s prior year-end fair market value (FMV) and divide it by the life expectancy factor published by the IRS. If you have multiple IRAs, each RMD must be calculated separately, but you’re free to take the total RMD amount from either one or a combination of the two. To help taxpayers with these calculations, the IRS provides online required minimum distribution worksheets.
Take the Stress out of RMDs with a Third Party Administrator
Ensuring you withdraw the correct amount for your required minimum distributions can be stressful. A third-party administrator from California Pensions can calculate your yearly RMDs and report them to the IRS for you. Learn more about the benefits of partnering with a third party administrator.
