If you have tax-deferred retirement accounts, you’ll need to take required minimum distributions (RMD) eventually. What yours will look like is determined by a number of factors, including your age and account balance. The IRS requires you to report this distribution on your annual taxes, so it has to happen by the end of each calendar year. Most retirees collect their required minimum distributions either annually, quarterly or monthly, with this decision revolving around what your financial plans look like. So long as you withdraw the minimum required amount by Dec. 31, the tax implications are unchanged.
A financial advisor can help you create a financial plan for your retirement. Speak to an advisor today.
What Are the Required Minimum Distributions?
A required minimum distribution is the amount of money you must withdraw each year from certain tax-advantaged retirement accounts. You can take out more than your RMD, but you must withdraw at least this much each year. The amount of your required minimum distribution is determined by your age and savings, and taxpayers can calculate it each year using the IRS’ Uniform Lifetime Table.
For anyone who turned 72 in 2022, they have until April 1, 2023, to take their first required minimum distributions (RMDs). However, this age requirement has been delayed until age 73 in 2023.The SECURE Act increased the age requirement for RMDs from 70.5 to 72 in 2019. And now,SECURE 2.0 has delayed it again from 72 to 73.
The purpose of an RMD is so that the IRS can eventually collect the taxes that it deferred when you made contributions to your various retirement accounts. It applies to accounts such as 401(k)s, IRAs and almost any other form of retirement account on which you don’t pay taxes. The only significant exceptions are Roth IRAs and other similarly situated accounts.
You must calculate a required minimum distribution for eachretirement account in your name. This means that if you have three different qualifying retirement accounts, you must calculate the required minimum distribution for all three accounts. If you fail to withdraw (and pay taxes) on a required minimum distribution, you can be taxed at up to 25% of the required amount. (For example, if you were required to withdraw at least $10,000 and did not do so, you can face a tax bill of up to $2,500.)
You can use an RMD however you see fit within the rules. The government just wants to make sure you eventually pay taxes on this money. The only restriction is that you cannot reinvest it in a tax-advantaged retirement account.
Annual Withdrawals
An annual withdrawal plan means that you calculate and withdraw your required minimum distribution in one lump sum each year. This is a perfectly acceptable approach to accounting since your required minimum distribution is set by a predetermined formula. You calculate it based on the value of your retirement accounts as of December 31 the year before and using the Uniform Lifetime Table that the IRS releases for each year’s tax filings.
So, for example, to calculate your RMD for 2023, you would use the value of your retirement accounts as of December 31, 2022, and the Uniform Lifetime Table applicable to 2023.
Most taxpayers who choose to make annual withdrawals do so either at the beginning or at the end of each tax year. This is a matter of personal accounting since you can withdraw this money at any time. The one exception is that in the first year that you qualify for a required minimum distribution, you must begin making these withdrawals by April 1. For all years afterward the IRS has no deadline other than the end of the year.
Whenever you choose to withdraw your minimum distributions, there are pros and cons to the annual approach. The benefits to annual withdrawals can include:
- Immediate resolution of your tax obligations:By withdrawing all of your required minimum distribution at once, at the start of the year, you get your tax obligation over with. This assumes you have taxes withheld from your distribution, and of the right amount.
- Reinvestment opportunities:If you have other strong investments, you can take your minimum distribution and invest it in those opportunities earlier, with more time for growth.
- Potentially better growth:Since this is a tax-advantaged account, the sooner you withdraw this money the sooner you pay taxes on it. By contrast, the longer you leave it alone the longer it can grow tax-deferred. Withdrawing it all at the end of the year can mean more growth in your retirement account over the long run. This is the biggest advantage of making annual withdrawals.
However, there are some downsides to annual withdrawals too. Those can include:
- Potentially higher estimated taxes:If you pay taxes quarterly, for example, if you own a business or generate self-employment income, you can significantly increase your estimated taxes by taking an early minimum distribution.
- Cash flow disruption:Some people need the structure of a regular income for their financial planning purposes, which a lump sum withdrawal can disrupt.
- Potentially forgetting:If you wait until the end of the year to make your minimum distribution, there’s a chance you’ll forget to do so altogether.
- Risk of spending the tax money:When you withdraw money from your retirement account, you must pay taxes on the profits that the account has accrued, as well as on the principal too. If you take your RMD early in the year, there’s a risk that you will spend the portion of that money that you will later need to pay taxes. (This ultimately depends on how you structure your account, as some retirement accounts will automatically withhold taxes on your behalf.)
Monthly/Quarterly Withdrawals
The other common approach to required minimum distributions is for retirees to take this money either every month or every quarter. As with annual distributions, there is no best way to handle this money. Some retirees prefer taking a lump sum distribution each year. Others prefer a series of smaller monthly withdrawals. It’s all up to you.
Readers should note that even this is not the only option. You can make distributions as frequently as your portfolio will allow transfers. However, monthly is the most frequent common approach.
The benefits of a monthly or quarterly approach can include:
- Cash flow management:Making monthly withdrawals allows you to treat this as a regular income. Many retirees prefer this style of cash flow over a lump sum format, as it helps with personal finance and budgeting. This is often the biggest advantage to making monthly or quarterly withdrawals.
- Estimated taxes:As noted in our section on annual withdrawals, if you pay quarterly taxes based on other income, having your required minimum distribution arrive in regular segments can make these estimated taxes easier.
- Tax payments:If you make monthly withdrawals, it’s often easier to have your portfolio manager automatically deduct any applicable income taxes so that you don’t have to worry about setting the money aside.
Some potential downsides to a monthly or quarterly approach can include:
- Reduced growth:The longer you leave your money in place, the more it can grow. If you take your withdrawals over the course of the year, your portfolio will lose some opportunities for growth based on reduced capital.
- Potential for miscalculation:While less of a concern if you work with a professional, if you withdraw your money in stages (rather than one lump sum) there’s more chance that you’ll miscalculate or otherwise make a mistake in your minimum withdrawal.
Ultimately, this comes down to the choice that’s best for your finances. In most cases we can recommend framing the issue this way: Your money has the most potential for growth if you take your entire minimum distribution at the end of each calendar year. However, personal budgeting may be easiest if you take your minimum distribution in 12 monthly portions.
If you do take your minimum distribution at the end of the calendar year, make sure you set up an automatic withdrawal. Even professional brokers can get distracted around Christmas and New Year’s, and you don’t want to discover that your sell order got held up by the holidays.
Bottom Line
You can take your required minimum distribution at any point, so long as it happens before the end of the year. Most retirees either take their money in one lump sum at the end of the year, to give it the most time to grow tax-free. Others withdraw their money each month, to give themselves a regular stream of income.
Tips for Retirement Planning
- According to the Federal Reserve, 60% of those with self-directed retirement accounts are not confident about their investment decisions. If you’re one of them, why not hire a financial advisor?Finding a financial advisor doesn’t have to be hard.SmartAsset’s free toolmatches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Getting the RMD right is extremely important. The tax implications for this are huge, with potential liability up to 50% of the entire amount. So make sure you know how to calculate your required minimum distribution.
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I'm an enthusiast with in-depth knowledge of tax-deferred retirement accounts and required minimum distributions (RMDs). To demonstrate my expertise, I'll provide information related to all the concepts used in the article you provided.
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Tax-Deferred Retirement Accounts: Tax-deferred retirement accounts are investment accounts that allow individuals to save for retirement while deferring taxes on contributions and investment gains until they make withdrawals in retirement. Common examples include 401(k)s and Traditional IRAs.
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Required Minimum Distributions (RMDs): RMDs are mandatory withdrawals that individuals with tax-advantaged retirement accounts must take once they reach a certain age. The RMD amount is determined by factors such as the individual's age and account balance. The purpose of RMDs is to ensure that the IRS collects taxes on the funds that were previously tax-deferred.
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IRS Reporting: Individuals are required to report their RMDs on their annual tax returns. This means that RMDs must be taken by the end of each calendar year and reported to the IRS accordingly.
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Age Requirement: Initially, individuals were required to start taking RMDs at age 70.5. However, the SECURE Act increased the age requirement to 72 in 2019, and SECURE 2.0 has further delayed it to age 73.
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Uniform Lifetime Table: The IRS provides a Uniform Lifetime Table that individuals can use to calculate their RMDs each year. This table takes into account factors like age and account balance to determine the required distribution.
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Tax-Implications: RMDs are taxable events, and the amount withdrawn is subject to income tax. Failing to withdraw the required amount can result in a significant tax penalty of up to 25% of the RMD.
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Exceptions: Roth IRAs are exempt from RMD requirements during the account holder's lifetime, as they are funded with after-tax dollars.
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Withdrawal Frequency Options: Individuals have options regarding how often they withdraw their RMDs, which include:
- Annual Withdrawals: Taking the RMD in one lump sum at the beginning or end of the year.
- Monthly/Quarterly Withdrawals: Spreading the RMD over smaller, regular payments throughout the year.
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Pros and Cons of Annual Withdrawals:
- Pros: Immediate tax resolution, reinvestment opportunities, potentially better growth.
- Cons: Potentially higher estimated taxes, cash flow disruption, risk of forgetting, risk of spending tax money.
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Pros and Cons of Monthly/Quarterly Withdrawals:
- Pros: Cash flow management, easier estimated taxes, automatic tax payments.
- Cons: Reduced growth potential, potential for miscalculation.
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Bottom Line: Individuals can choose the withdrawal frequency that best aligns with their financial goals. Taking the entire RMD at the end of the year maximizes growth potential, while monthly withdrawals provide regular income for budgeting.
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Tips for Retirement Planning: Hiring a financial advisor is recommended for those who lack confidence in their investment decisions, as the implications of RMDs can be significant. SmartAsset's tool matches individuals with financial advisors who can help them achieve their retirement goals.
In conclusion, understanding RMDs and how to manage them is crucial for anyone with tax-deferred retirement accounts. The timing and frequency of RMD withdrawals should be based on individual financial circ*mstances and goals. Consulting a financial advisor can provide valuable guidance in navigating the complexities of retirement planning and RMDs.
