How Required Minimum Distributions Impact Your Traditional IRA Balance

Required minimum distributions (RMDs) are mandatory withdrawals from retirement plans, including traditional individual retirement accounts (IRAs). Neglecting to take these withdrawals in a timely manner may lead to hefty penalties.

This is why including RMDs in your savings and income projections is essential for creating a tax-efficient financial strategy in retirement. Learn about the rules regarding RMDs in this guide.

Key Takeaways

• You will be required to start taking RMDs at a certain age, which depends on your birthdate and is specified by IRS guidelines.
• RMDs are taxed at ordinary income tax rates.
• Failing to take the mandated RMDs can result in a significant penalty of 25% of the undistributed amount.
• Consult a financial professional to understand the IRS guidelines and proper calculations for RMDs based on your financial circumstances.

What Are the Rules for Required Minimum Distributions (RMDs)?

Withdrawing Funds From Your Traditional IRA

Though you can withdraw money from your traditional IRA whenever you want, doing so before you turn 59½ typically incurs a 10% tax, a marginal tax rate based on your income the year you withdraw. Deductible contributions and earnings you withdraw from your traditional IRA are taxable.

There are other exceptions under which you may be able to withdraw money penalty-free, but for now, we’ll focus on withdrawals that meet the proper requirements and, more specifically, required minimum withdrawals.

Why Do You Have To Take RMDs?

You don’t have to take your money out of your traditional IRA by the age of 59½, but you can’t keep your funds in the account indefinitely, either. This is where RMDs come in. 

These distributions are the minimum amounts the IRS requires you to withdraw each year from your retirement accounts once you reach a certain age. These rules apply to traditional IRAs, 401(k)s, and other similar plans, but in this article, we’ll focus on traditional IRAs.

RMDs ensure you eventually pay taxes on your retirement savings, where contributions were previously tax-deferred. You should know that these withdrawals are taxed as ordinary income for the year you make the withdrawals. There are also specific IRS guidelines on RMDs work, so here’s what else you should know.

When Do You Start Taking RMDs?

According to IRS rules, you must start taking RMDs from your traditional IRA at a certain age. Though this age has changed a few times, the SECURE 2.0 Act raised the age for beginning RMDs to 73 if you reach 72 after Dec. 31, 2022. This change allows you to delay withdrawals slightly more than before and may affect your retirement planning and tax liability.

Once you turn 73, you must start taking your RMDs by April 1 of the following year. This deadline applies specifically to your first RMD. For subsequent years, you must take your RMD by December 31. You may be subject to IRS penalties if you don’t meet these deadlines.

How To Calculate Your Traditional IRA RMD Amount

To determine your RMD for each account, you’ll take the balance from your IRA or retirement plan account as of December 31st of the previous year. Then, divide that amount by a life expectancy factor. The IRS provides this factor in tables found in Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs).

Though the rules vary based on specific circumstances, if you’ve got a straightforward situation, calculating your RMD is simple. As an example, let’s assume that the owner of a traditional IRA falls into one of these categories:

• Unmarried
• Married, but their spouse is not more than 10 years younger than the account owner
• Married, but their spouse isn’t the sole beneficiary of the account

With these circumstances, we’ll use the Uniform Lifetime Table (Table III) to determine their RMD.

Further, let’s say that this account holder is 87 years old and has a traditional IRA balance of $1,200,000 as of December 31, 2023. To figure out their RMD, we would follow these steps:

1. Determine the account balance: Start with the balance of the traditional IRA as of December 31, 2023, which is $1,200,000.
2. Find the applicable life expectancy factor: For a single owner calculating their RMD at age 87, the Uniform Lifetime Table indicates the distribution period or withdrawal factor is 14.4. (Verify this figure with the IRS table for the current tax filing year, as these publications are updated annually, and this factor may also change.)
3. Divide $1,200,000 by 14.4 to get $83,333.33

Based on this calculation, the RMD for the year 2024 would be approximately $83,333.33. This amount is the minimum the account holder must withdraw for the year to comply with IRS regulations. Failure to withdraw the required minimum could result in tax penalties.

Remember that your required minimum distribution can also be affected by the timing of your withdrawal, any changes in your marital status or beneficiary’s age, and the account owner’s death. Consequently, these factors can cause your RMDs to vary, making them higher or lower than indicated.

Tip

If you’re not comfortable doing these calculations manually, you can use an online RMD calculator, like the one provided by the Investor.gov website. 

Whether you calculate this figure by hand or with the help of an online resource, consult with a tax professional to get the most accurate figures for your situation.

RMD Deadlines and Exceptions

Deadlines for Taking RMDs

For your first RMD, you have until April 1 of the year following the year you turn 73 to make your withdrawal. After this first RMD, you must meet the deadline of December 31 each year.

If you don’t take out the entire amount of your RMD by the deadline, the amount you didn’t withdraw may incur a 25% tax penalty. Before 2023, this penalty was 50%; however, the SECURE 2.0 Act reduced the percentage. You could even cut it down to 10% if you fix the missed RMD within two years.

How To Delay Your First RMD

As mentioned above, if you choose to delay your first RMD to April 1, you must still withdraw your second RMD by December 31 of that same year, resulting in two taxable distributions in one year.

This scenario could change your income and, consequently, your tax bracket for that year. Consider consulting a financial advisor to evaluate whether deferring the first RMD is best for your situation.

How To Receive Your RMD

Once you know the amount you must withdraw for a given tax year, contact the financial institution where your retirement account is held. You can receive your RMD as a lump sum or throughout the year. Most financial institutions give you options, such as a check or direct deposit into your chosen bank account.

Are RMDs Taxed?

Yes, RMDs are taxed as ordinary income based on your tax bracket. The rate varies from 10% to 37% in 2024 and 2025, depending on your income level.

What Is the 4% Rule for RMDs?

The 4% rule suggests retirees plan to withdraw 4% of their retirement savings annually, adjusting for inflation, to ensure funds last 30 years. This is a general guideline for retirement withdrawals, and it may differ from RMD rules.

At What Age Do RMDs Stop?

RMDs typically stop when your retirement account is depleted or when you, as the account owner, pass away. However, specific rules might apply based on the retirement plan terms or changes in IRS regulations.

At What Age Can You Withdraw From an IRA Without Penalty?

You can withdraw from an IRA without penalty starting at age 59½. Withdrawals before this age may incur a 10% early withdrawal penalty unless an exception applies.

The Bottom Line

Under most circumstances, you’ll need to start taking RMDs from your traditional IRA by age 73 to avoid tax penalties. As you age and your IRA balance changes, your RMDs and related tax obligations will differ. For this reason, consider working with a tax advisor to ensure you meet all RMD requirements to avoid additional fees or penalties.