Planning for retirement may not sound exciting, but when you are able to leave the working world behind, you’ll be glad you planned ahead and saved up. When you calculate how much you will get from Social Security payments, you can figure out how much you need to save separately so you will be able to live the retirement you want.
Whether you save using a 401(k), IRA, other method or a combination, it’s a good idea to learn the guidelines and rules of your savings plan(s). For example, some plans require you to take money out of your accounts as you age. It’s important to learn about and understand required minimum distributions so you can make educated contribution, living and withdrawal decisions.
What Are They?
It turns out that you can’t keep your retirement funds tucked away in (all) tax-advantaged savings account forever. Your required minimum distribution, or RMD, is the minimum amount you must withdraw from your retirement savings account each year, starting the year you turn 70½.
You can withdraw more than the minimum required amount but not less. Your withdrawals will be considered taxable income except for any part that was taxed before or can be received tax-free. SEP-IRAs, SIMPLE IRAs, traditional IRAs, 401(k)s, 403(b)s, 457(b)s, profit-sharing plans and other defined contribution plans all come with required minimum distributions. (Roth IRAs are funded with after-tax money and do not require you to make withdrawals.) At the time you start taking distributions, you also must stop making contributions.
Why Do RMDs Exist?
The IRS doesn’t let you wait for as long as you want to start using your retirement savings because these accounts feature tax-deferment. This means the IRS is getting nothing out of your savings from the time you first open your account to the time you turn 70½ (assuming you have not made withdrawals). The IRS is not about to let you defer your taxes indefinitely, so they impose required minimum distributions to ensure they get taxes on these funds.
How Are RMDs Calculated?
Your age, account balance, estimated rate of return, marital status and life expectancy are all used to calculate your yearly RMD. To calculate this year’s number, you take the account balance at the end of the previous calendar year and divide it by the “distribution period” that the IRS assigns on its Uniform Life Table. This “distribution period” is essentially the number of years they expect you have left. There are several exceptions and complications that may be unique to your situations and affect your RMD. The IRS site has plenty of details to help answer common questions, or you can consult a tax professional or financial adviser.
RMDs may sound complicated, but they are important to understand so you can be ready. This can help you avoid paying penalties.
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