Required minimum distributions (RMDs) are important to consider when planning for retirement

• Required minimum distributions (RMDs) are withdrawals you have to make from retirement accounts annually.
• RMDs usually start at age 72, but it can be useful to account for them much earlier.
• Failing to take out enough to satisfy RMDs can trigger large tax penalties.
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Required minimum distributions (RMDs) are the minimum amounts that have to be withdrawn each year from many types of retirement accounts. They typically apply to those who are age 72 and up, though certain exceptions can apply.

The money you take out as an RMD generally counts as taxable income. So, rather than letting your retirement account grow tax-free indefinitely while living off other sources of income, the IRS has rules in place that prompt you to draw down at least some of your retirement funds. If you don't, you could be hit with even larger tax penalties.

Because you'll probably have to withdraw some money from accounts like an individual retirement account (IRA) or a 401(k) eventually, it's worth factoring that into your retirement planning well in advance of your 70s. 

"If you don't properly plan, you could end up with an RMD that's much larger than you need to take out to meet your cash flow needs," says Valerie Harman, a tax and financial planner at Buckingham Advisors.

So, rather than putting all your savings into a retirement account that will have RMDs, you might want to put some money into ones that do not have these same restrictions. 

"For example, Roth IRAs and non-qualified accounts should be part of most people's retirement savings plans, because those types of accounts do not have RMDs, and they also provide opportunities to manage your taxable income," adds Harman.

How is an RMD calculated? 

Most types of retirement accounts have RMDs, including:

• Traditional IRAs
• Traditional 401(k)s
• Roth 401(k)s
• SEP IRAs
• SIMPLE IRAs
• 403(b)s
• 457(b)s 

Profit-sharing plans and other types of defined contribution plans are also generally subject to RMDs. 

However, Roth IRAs do not have any minimum withdrawal requirements during the account owner's lifetime, though certain rules apply for beneficiaries.

When it comes to calculating RMDs, the amount isn't a fixed number or a percentage that always stays the same. Instead, an RMD is based on two factors:

1. The account balance at the end of the previous year 
2. The distribution period, as determined by the Internal Revenue Service

To complete the calculation, simply divide the account balance by the distribution period. The distribution periods are related to life expectancy, so when you start having to take RMDs at age 72, it will be higher. As you get older, the distribution period decreases, meaning a larger proportion of your retirement account balance would need to be withdrawn.

These numbers are available in the IRS Uniform Lifetime Table, which is the most commonly used standard calculation table used. Of course, exceptions apply, such as for those who have a spouse more than 10 years younger and who are the sole beneficiary of the retirement account in question.

For example, the Uniform Lifetime Table for 2022 shows that for someone who's 75, the distribution period is 24.6. So, if a 75-year-old wanted to calculate their RMD based on a $1 million IRA balance, they would divide 1 million by 24.6, which equals $40,650.41. An 85-year-old would use a factor of 16, which would produce an RMD of $62,500 based on the same $1 million balance.

The good news is that you don't necessarily need to make RMD calculations yourself.

"Typically, your financial advisor, or perhaps the custodian where you hold that [retirement account] will calculate that RMD amount for you annually," says Harman.

2022 Uniform Lifetime Table (through age 95)

Source: Federal Register

When must I start taking required minimum distributions? 

RMDs generally kick in at age 72, though there are some important nuances to understand. 

For one, you don't have to take an RMD as soon as you turn 72. Instead, you have until April 1 of the following year from when you turn that age. After that, you must take your RMD by Dec.r 31 each year. That can mean you take two RMDs in the first calendar year you start making these withdrawals.

Another important nuance is that for employer-sponsored plans, such as 401(k)s, you may be able to wait longer to take your RMDs. That's because the IRS rules apply to the later between turning 72 and the year in which you retire, assuming your plan allows you to keep your assets there. So, it's possible that if you're still working past age 72, your employer-sponsored plan may enable you to delay taking RMDs.

Also note that if you have more than one retirement account, you'll have to calculate the RMD for each one. But if you have multiple IRAs, you could then combine these RMD amounts into one sum and take that money out of just one account. However, for many types of employer-sponsored plans, besides 403(b)s, you have to take the RMDs out of each account separately. 

What if I don't withdraw the required amount? 

If you don't withdraw enough to satisfy your RMD each year, you could have to pay an additional tax that equals 50% of the gap between what you withdrew and your RMD. 

That said, there can be ways to avoid this penalty. For example, you could file Form 5329 and include an explanation as to why a reasonable error was made and how you're fixing this error, in which case you could qualify for a waiver.

You also may be able to satisfy the RMD without putting the money into your own accounts if you want to avoid increasing your taxable income. To do so, you could potentially make a qualified charitable distribution from an IRA, where your trustee directly distributes your RMD amount to a charity.

Not everyone necessarily has the financial ability to donate their full RMD amount, but it's an option to think about as part of your overall tax and retirement planning. In general, accounting for these RMDs before you have to actually take them can go a long way toward improving your finances.

"Start planning for your RMDs early in life," says Harman. "Like any sort of planning, the sooner you make a plan and start to implement that plan, the better your chances are for greater success."