What are RMD's & when do I have to take them?

Required Minimum Distributions

Tax-deferred retirement accounts like employer-sponsored 401(k) plans are designed to help people save for retirement. There are many benefits to saving for retirement through a 401(k). However, it’s important to understand some of the rules pertaining to 401(k) plans. One rule often overlooked is mandatory withdrawals or RMDs.

Mandatory withdrawals from a 401(k) are annual withdrawals made from a 401(k) required by the IRS. Starting at 72, the mandatory withdrawals are calculated using the IRS RMD worksheet. Amounts equal the balance of your 401(k) divided by a distribution period between 25.6 and decreasing annually to 1.9 when you reach 115. For example, if you have $1 million in your 401(k) when you turn 72, you divide $1 million by 25.6 giving you a mandatory withdrawal amount of $39,062.50 for that year.

Each annual amount must be withdrawn from the eligible account by December 31 of each year or be subject to stiff penalties.

To avoid this from happening to you, let’s go over in more detail what you need to know about mandatory withdrawals from your 401(k).

reHow to Calculate Your Mandatory Withdrawal Amount

Once you turn 72, you are required to withdraw a specific amount from your 401(k) each year. You must take out this amount by December 31 of each year to avoid penalties. Take out too little, and the remaining amount will still be penalized.

To make sure you are withdrawing the correct amount from your 401(k), the IRS provides a calculation so you can zero in on the exact amount you need to withdraw.

To get your annual amount, divide your 401(k) balance as of December 31 of the previous year by your life expectancy factor.

Your life expectancy factor is taken from the IRS Uniform Lifetime Table.

An exception to this requirement is if your spouse is the only primary beneficiary and they are 10 years younger than you, use the IRS Joint Life Expectancy Table instead.

How Are Mandatory Withdrawals Taxed?

Because you contributed to your 401(k) with tax-deferred income, the government still wants their share. The reason mandatory withdrawals are required is to ensure the income you contributed to your 401(k) doesn’t go without contributing to the greater good of Uncle Sam.

Just like other distributions during retirement, mandatory withdrawals are taxed as ordinary income.

Additionally, mandatory withdrawals count towards your overall annual taxable income. So if you are still working, these withdrawals from your 401(k) could lift you into a higher tax bracket.

Lastly, the tax obligations of mandatory withdrawals don’t stop with your federal taxes. State and local taxes may be applied to these withdrawals as well.

What Are the Penalties for Not Taking Mandatory Withdrawals?

Failing to withdrawal the required amount each year could cost you a pretty penny. Although the IRS has been waiting patiently to get their share of your retirement via income tax, they aren’t too patient once you reach 72.

Any mandatory amount that hasn’t been withdrawn from a 401(k) by December 31 of the applicable year will be subject to a 50 percent penalty.

If your calculated mandatory amount is $10,000 and you fail to withdraw it, you could lose $5,000 automatically.

It’s best to review your mandatory withdrawal amount at the beginning of each year and make a plan to withdraw that amount before the end of the year.

What Are the Exceptions to Mandatory Withdrawals?

Despite IRS imposing these mandatory withdrawals and penalties, there are scenarios that allow you to delay taking money out of a 401(k).

If you’re 72 and older and still working for the company that sponsors your 401(k) plan and don’t more than 5% of that company, you can delay your mandatory withdrawals.

However, if you leave that company, you will be required to begin taking mandatory withdrawals from that 401(k) plan.

Additionally, this exception only applies to the 401(k) plan held by that employer. Any old 401(k)s with former employers you still have are subject to mandatory withdrawals.

To avoid this, it’s best to periodically check for old 401(k)s and roll them over to your current 401(k) or IRA.

Mandatory Withdrawals From Other Retirement Accounts

The IRS mandatory withdrawal requirements don’t only apply to employer-sponsored 401(k) plans.

Traditional IRAs, SEP IRAs, SIMPLE IRAs, 403(b)s, and 457(b)s are all subject to the same mandatory withdrawal guidelines.

There is only two retirement accounts that do not require mandatory withdrawals, one is Roth IRAs and the other is CVLI/LIRP. Since you pay taxes on the amount you contribute to a Roth IRA, the IRS has already received taxes on that amount. With your LIRP, none of the RMD rules apply. You have full liquidity at any time for any reason.

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