The Rule of Retirement: A Guide to RMDs

Throughout your working years, the government provides significant tax advantages for saving in retirement accounts like a Traditional IRA or a 401(k). Contributions can be tax-deductible, and the investments grow tax-deferred, meaning you don't pay any taxes on the gains year after year. However, this tax deferral is not indefinite. The government eventually wants its share. The Required Minimum Distribution (RMD) is the minimum amount of money that you are legally required to withdraw from most types of retirement accounts each year once you reach a certain age.

Failing to take your RMD on time is one of the most costly mistakes a retiree can make, as the penalty can be severe—up to 25% of the amount that should have been withdrawn. The purpose of the RMD rule is to ensure that individuals spend their retirement savings during their lifetime and don't use these tax-advantaged accounts simply as a way to pass on wealth to their heirs tax-free. Understanding when you need to start taking RMDs and how to calculate the amount is a critical part of managing your finances in retirement.

Who Needs to Take RMDs?

RMD rules generally apply to tax-deferred retirement accounts, including:

• Traditional IRAs
• SEP IRAs
• SIMPLE IRAs
• 401(k), 403(b), and 457(b) plans

Notably, Roth IRAs are exempt from RMD rules for the original owner. You are never required to take withdrawals from a Roth IRA during your lifetime.

When Do I Have to Start?

The age at which you must begin taking RMDs depends on your birth year. Due to the SECURE Act and subsequent legislation, the starting age has been updated. As of current rules, if you were born in 1959 or earlier, you must start taking RMDs at age 73. If you were born in 1960 or later, the age is 75. Your first RMD must be taken by April 1st of the year *after* you reach the required age. For all subsequent years, the RMD must be taken by December 31st.

How RMD is Calculated: The Uniform Lifetime Table

The RMD calculation is straightforward. For each year, you take the total value of all your applicable retirement accounts as of December 31st of the *previous* year, and you divide that amount by a 'life expectancy factor' provided by the IRS in their Uniform Lifetime Table. This table gives a distribution period based on your age for that year.

Formula: RMD = (Total Account Balance as of Dec 31 of prior year) / (Life Expectancy Factor)

For example, if you are 75 years old and your total IRA balance was $500,000 at the end of the previous year, you would look up the factor for age 75 in the table (which is 24.6 for 2024). Your RMD for the year would be $500,000 / 24.6 = $20,325.20. An RMD calculator automates this lookup and calculation process for you.

The Cost of Forgetting

It's critical to take your full RMD on time. If you fail to do so, the amount not withdrawn is subject to a significant excise tax. While the penalty was previously 50%, it has been reduced, but it remains substantial at 25% of the shortfall. This penalty can be further reduced to 10% if you correct the mistake in a timely manner. Given the severity of this penalty, managing RMDs is a key responsibility for any retiree with tax-deferred savings.