Let’s tackle one of everyone’s favorite and most confusing retirement topics – the good old RMD. RMD stands for Required Minimum Distribution. This is when Uncle Sam says it is time for you to pay some taxes on all these tax-deferred IRAs you have enjoyed over the years, but not Roth IRAs as they do not have RMDs. For this example, I am going to focus on the normal RMD connected to your own IRA balance you have accumulated over the years of saving and investing.
RMDs come into play when a retiree hits age 70, or 70 ½ half to be specific. The exact time of when you have to take your RMD is based on whether your birthday is in the first or second half of the year. If you are born in the first half of the year you will turn 70 ½ in the same calendar year as your birthday. In this case, your first RMD will be due by April 1st of the next year. If your birthday is in the second half of the year, you will turn 70 ½ in the next calendar year, so you do not have to take the first RMD until the following April. However, every RMD is then due by December 31st after that initial RMD, including if you took the first RMD on March 31st.
Regardless, let’s talk about how your RMD is calculated if you are retired and hit the magic age of 70 ½.
First, you need to know the value of your IRAs at the previous year’s end. Let’s say in this example you had $1,000,000 between two IRAs on December 31st last year. In the next step you need to reference the IRS Uniform Table III. This provides you the divisor for your distribution. For someone turning 70 the divisor is 27.4. You take the $1,000,000 and divide it by 27.4. Your RMD is now just under $36,500 this year. Now, Uncle Sam doesn’t care what you do with that money as long as that $36,500 comes out and you pay taxes on it. If you don’t take it out on time there is a hefty penalty of 50%.
Where it gets more complex is the divisor decreases by roughly 1 every year as you age. Let’s fast forward to age 85 and imagine your original IRA balance grew back to $1,000,000 even after all the preceding RMDs. Your RMD at 85 would be nearly $68,000 because your divisor is now 14.8.
So, quick overview of RMDs. Not super complex but worth making sure you do it right. It does get more complex if you are dealing with an inherited IRA, especially depending if it is spousal or non-spousal. Again, not too complex, but worth talking to a CFP® to make sure you are doing it properly.
My final point, and please pay attention here – If you turned 70 last year and have not yet taken out your RMD you may need to before April 1st! Please double-check with your CFP® to make sure you are in good shape so you don’t have to worry about the penalty.