What are Required Minimum Distributions?
Whether you’re already retired, approaching retirement, or still saving for retirement you may have heard of that your accounts may be subject to required minimum distributions (RMDs).
RMDs are not discussed often, but they affect anyone who is saving for retirement in a qualified account. A couple of examples of qualified accounts include a 401(k) plan and a traditional IRA. When you contribute to a 401(k) plan, you are doing so on a pre-tax basis. This means that you are not paying income taxes on those contributions now, but the catch is that you will need to pay income taxes when you withdraw money from the 401(k) plan.
There is another catch. At some point, you must make withdrawals from the account. The minimum amount that you are required to distribute is based on the account balance at the end of the previous year and your age at the end of the current year - it’s slightly confusing, but there are plenty of calculators available online to calculate your RMD. The age when you must start taking RMDs depends on your birth year, but it varies between ages 70 1/2 and 75 under current legislation.
People are often unpleasantly surprised to discover they must make withdrawals from their qualified accounts, especially if they don’t need the funds. But, this does not make qualified accounts “bad” at all. Deferring taxes until retirement can be very advantages since any interest, dividends, and gains that occur in the account are not taxed - only the withdrawal itself is considered taxable income. It is incredibly important to satisfy the RMD each year since the penalty can be as high as 25% of the amount you missed.
This blog post is focused solely on qualified accounts that the original owner contributes to and it does not even mention qualified accounts that were inherited. Inherited qualified accounts will have RMDs and the rules are a little more complicated. An effective strategy is to understand how your assets are allocated from a tax-perspective (pre-tax, Roth, taxable) and develop a withdrawal plan that works for your personal situation.
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