If you have tax-deferred retirement accounts such as a traditional IRA or most 401(k) plans, you're required to begin taking required minimum distributions, or RMDs, once you turn 70 1/2 years of age. Each year, your RMD is determined by your age and account's value, and the penalty for not taking your RMD is quite harsh.
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Required minimum distributions 101
If you have savings in tax-deferred retirement accounts, such as a 401(k) or traditional IRA, you are required to start taking withdrawals from these accounts after you reach 70 years of age. These are known as required minimum distributions, or RMDs.
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In other words, the IRS doesn't allow you to defer paying taxes on your retirement savings forever -- you need to start withdrawing a minimum amount of money once you get older, which will then be counted toward your taxable income. After-tax retirement savings accounts, such as Roth IRAs and Roth 401(k) contributions, are not subject to the RMD requirement. The IRS doesn't get to tax withdrawals from these accounts, so therefore they don't really care how long you leave your money in them.
Required minimum distributions generally must be taken by December 31 each year. For example, if you're 75 this year, you'll need to take the appropriate RMD for your age by the end of the year.
While this is normally the case, the rules for your first RMD are different. Specifically, you have until April 1 of the calendar year after the year in which you reach 70 years of age to take your first RMD. For example, if you turned 70 on February 1, 2017, you have until April 1, 2018 to take your first RMD. However, if you wait until the last minute to take your first RMD, you'll end up taking two during the same calendar year (your first, plus the one you'll be required to take in 2018). This can result in a lot more taxable income than you had planned on, and could potentially result in a hefty tax bill.
It's also worth mentioning that if you have several accounts subject to RMD requirements, you don't necessarily need to take money out of each one. As long as your calculated required minimum distribution is withdrawn from some combination of your tax-deferred retirement accounts, you are in compliance with the rules.
How to calculate your required minimum distribution
Broadly speaking, your required minimum distribution for each year is based on your remaining life expectancy.
To calculate your RMD for a tax-deferred retirement account, you first need to obtain your account's balance at the end of the preceding calendar year. So, whatever was in your account at the end of December 31, 2016 is what you'll use to calculate your 2017 RMD.
Then, you'll use one of two IRS life expectancy tables to find your "distribution period". In most cases, the Uniform Lifetime Table is used. However, if your retirement account's sole beneficiary is your spouse and he or she is more than 10 years younger than you, you'll use the Joint Life and Last Survivor Expectancy Table.
Once you find your expected distribution period, you divide your account's balance at the end of last year by this number to determine this year's RMD.
For example, let's say that you were born on December 1, 1940, which makes you 76 years old. We'll say that your spouse is roughly the same age as you, so you would use the Uniform Lifetime Table, which shows a life expectancy factor of 21.2. So, if you have $1 million in your retirement accounts, you'll be required to withdraw at least $47,170 by the end of 2017.
Better yet, here's a calculator that can do the hard work for you:
* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
You don't want to forget to take your RMD in 2017
It's important to be aware that under no circumstances should you fail to take your RMD in any given year. The penalties the IRS assesses for failure to take a RMD are among the harshest of all.
Specifically, if you don't take your RMD by the deadline, you'll face a penalty equal to half of the amount you were supposed to withdraw. So, if you were supposed to withdraw $30,000 by the end of 2016 and failed to do so, the penalty you'd have to pay would be a whopping $15,000.
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