What is RMD?
RMD = Required Minimum Distribution
A required minimum distribution is the amount that traditional, SEP or SIMPLE IRA owners and qualified plan participants must begin withdrawing from their retirement accounts by April 1 following the year they reach age 70 1/2. The retiree must they withdraw the RMD amount each subsequent year based on the current RMD calculation.
BREAKING DOWN 'Required Minimum Distribution - RMD'
These required minimum distributions are determined by dividing the retirement account's prior year-end fair market value by the applicable distribution period or life expectancy. Some qualified plans allow certain participants to defer beginning their RMDs until they retire, even if they are older than age 70 1/2. Qualified plan participants should check with their employers to determine whether they are eligible for this deferral. Also, Roth IRAs do not require withdrawals until after the owner dies.
It should be noted an investor is allowed to withdraw at least the required minimum distribution but may withdraw any amount above that amount. If an investor wants to withdraw 100 percent of the account in the first year, that withdrawal is legal.
When calculating a required minimum distribution for any given year, it is always wise to confirm on the Internal Revenue Services website that you are using the latest calculation worksheets. Different situations call for different calculation tables. For example, IRA account holders whose spouse is the account's only beneficiary and is more than 10 years younger than the account holder use one table, while IRA account holders whose spouse is the account's only beneficiary and the same age as the account holder use a different table.
The RMD calculation involves three simple steps. First, write down the account's balance as of Dec. 31 of the previous year. Second, find the distribution factor listed on the calculation tables that corresponds to your age on your birthday of the current year. For most people, this factor number ranges from 27.4 all the way down to 1.9. As a person gets older, the factor number goes down. The third step is to divide the account balance by the factor number to find the RMD.
For example, say it is May 15 and the account holder is 74 years old and their birthday is on Oct. 1. Their IRA is worth $225,000 and had a balance of $205,000 on Dec. 31 of the previous year. The distribution factors from his relevant IRS table are 23.8 for age 74 and 22.9 for age 75.
The RMD is calculated as:
RMD = $205,000 / 22.9 = $8,951.97
A Special Case: Inherited IRAs
Generally, with an Inherited IRA, an account holder must take annual distributions regardless of their age. Failure to take the distribution results in a 50 percent tax penalty on the RMD.
Read more: Required Minimum Distribution