If you have retirement accounts like a 401(k) or traditional IRA, then starting the year you turn 70.5, you will be required to start taking withdrawals from those accounts. These mandatory annual withdrawals are called required minimum distributions. It is essentially the government’s way of pushing you to move money out of your tax-deferred accounts so that it can finally be taxed. Many retirement savers are aware that they exist, but when it comes to calculating required minimum distributions, they are unsure of how to go about it.
How are required minimum distributions calculated?
There are two main factors that go into the formula of calculating required minimum distributions: the amount of money in the retirement account and the life expectancy of the account holder. Each year, the IRS calculates your required minimum distribution by taking your account value at the end of the previous year and dividing it by its “life expectancy factor,” which is based on how long an account holder is expected to live.
A table located in this IRS document outlines these life expectancy factors, which apply to most individuals. If you have a spouse who is more than 10 years younger than you and who is your sole beneficiary, both of your ages will be factored into determining your required minimum distribution (there is a separate table for this in the same document).
If you have multiple retirement accounts, then you may have to calculate required minimum distributions differently depending on the type of accounts you have. If you have multiple 401(k)s, you will just calculate required minimum distributions separately for each account. But if you have multiple traditional IRAs or 403(b)s, you are allowed to total the required minimum distributions from each account and take the entire distribution from just one of them.
In general, required minimum distributions increase as your life expectancy decreases, but the amount of account growth or decline in any given year can affect the amount of your mandatory withdrawal. Consult an IRS worksheet to help in calculating your required minimum distributions.
What happens if I don’t take required minimum distributions?
Keep in mind that some investors may already take out more than their required minimum distribution even before they turn 70.5. However, others who do not need to access their accounts until later in life need to remember to take required minimum distributions to avoid penalties.
Penalties for not taking required minimum distributions are steep. If you do not meet your required minimum distribution by the end of the year, you will be taxed 50 percent on the undistributed amount—on top of any regular taxes that are due on the withdrawals. Having the penalty waived is only possible if you can convince the IRS that it was due to a “reasonable error.”
If you are worried about calculating the correct amount of your required minimum distributions, remember that the administrator of your retirement accounts will typically calculate them for you and automatically deduct them if that is what you want. Calculating them yourself ahead of time, however, serves the purpose of helping you plan your retirement budget.
If you are looking for a retirement investing vehicle that can guarantee the protection of your principal while offering reasonable average growth between 6 and 8 percent, our knowledgeable Ty J. Young Inc. advisors can help. Give us a call today at 877-912-1919!