What is an RMD?

by Neal Frankle, CFP ®

If you own an IRA and you’re approaching age 70 ½, you’ll be forced one day soon to take an RMD. What is an RMD? It’s a Required Mandatory Distribution, and it’s one of the most important IRA rules there are. In other words, the government will force you to start taking money out of your IRA.

Why does the government force you to make withdrawals from your retirement account? Because they want those tax bucks. Remember, when you put money into your IRA you got a tax deduction. As the account grew, you paid no tax whatsoever. Now the government wants its money. Every penny you take out of your retirement account is taxable as income. So the government forces you to start making withdrawals from those accounts for one reason only. They don’t care about you. They just want to tax you on the withdrawals.

How much are you forced to take out?

The Treasury publishes a table in Publication 590 that you can use to determine how much you must withdraw each year. The percentage rises each year. The Treasury wants you to take a larger percentage each year because they want you to withdraw most of the money before you reach age 90. Here’s a bird’s-eye view of one section of the table.

what is an rmd

You can see that if you are 70 ½, your number is 27.4. That’s the divisor. All you have to do is take the value of your IRA from the prior December 31st and divide it by 27.4. That’s your RMD. Now, if you notice, you’ll see that the divisor for the following year goes down to 26.5, and that’s the number you’ll use at that point. Let’s take an example.

Assume you have $100,000 in your IRA as of 12/31/10. Calculate your RMD by taking $100,000 and dividing it by 27.4. The number is $3,649. That’s your RMD.

Next year, the value is $105,000. It’s true that you withdrew $3649, but the investments did well and the account more than made up for that reduction. Now, take $105,000 and divide it by 26.5. At this point, your RMD is $3,962. Easy as pie. Different tables are used depending on your age and marital status.

Can you invest the money you are forced to withdraw?

You can decide how you want to invest your IRA withdrawals. You can spend it or take it and put into your living trust account. The only thing you can’t do is deposit it back into a retirement account.

What if you are still working?

If you’re still working, you still have to take your RMD. Sorry.

What if you don’t want the money?

Too bad. The word “required” means required. It doesn’t mean “suggested.”

What if you don’t take the money?

Oh, that would be a big mistake. The government won’t like that very much at all. For every dollar of your RMD that you fail to withdraw (and pay tax on), the government will slap a 50% penalty on you.

What is the most confusing thing about RMDs that you have encountered?

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