In my last post we learned that some retirement accounts have rules that force you to begin taking distributions by a certain age even if you’d rather not. Today I’ll show you how to run through the math of how much you might be required to take out of your retirement account if you reach that age.
Retirement Account Minimum Withdrawal Calculations
This is where your head can really start to spin. There’s some math involved with figuring out how much money you can take out of your retirement accounts, and how much money you must take out if your account has a required distribution age. But I encourage you to really work hard to understand all of the rules.
Why? Because this is critically important: if your retirement account requires you to take a minimum distribution (a 401k or Traditional IRA) and you do not take that distribution, you will be fined 50% of the amount of the distribution PLUS having to pay taxes on the distribution when you do end up taking it.
Imagine your RMD is $1,000 this year and your tax bracket is 25%. You don’t take the distribution. The government fines you 50% = $500. Then you take the RMD of $1,000 and pay 25% tax of $250. You would pay $750 to take a $1,000 late distribution!
Traditional IRA – Required Minimum Distributions
Since withdrawals from a Traditional IRA are taxable the government really wants you to hurry up with withdrawing money from your traditional IRA. They want to collect those tax dollars eventually. The Traditional IRA thus has both an age where you must begin to take distributions (discussed above), and a minimum amount that you must withdraw. This is called a Required Minimum Distribution or RMD. To calculate your Required Minimum Distribution you must first know the value of all of your IRA accounts (not including Roth IRAs — remember, you were already taxed on the dollars you put into your Roth IRA). So if you’ve got $100,000 in one Traditional IRA and $250,000 in another Traditional IRA the total value of $350,000 is considered. Once you have that amount the IRS provides a table of life expectancy rates. They are available on two PDF files.
- You can find the uniform life expectancy table on page 106 of Publication 590 (Individual Retirement Agreements)
- You can also use this handy, and much smaller, IRA Required Minimum Distribution worksheet to calculate your distribution.
You plug in the value of your IRAs and the age you are taking your RMD. You divide the amount by the distribution period. The result is how much you must withdraw this year from your IRA. How about an example?
- You have $350,000 total over two different Traditional IRAs.
- You are age 75.
- The distribution period from the above forms for age 75 is 22.9.
- Divide $350,000 by 22.9
- Result = You must withdraw a total of $15,283.84 from your IRAs this year.
- You pay tax on the amount you withdraw.
401k – Required Minimum Distributions
Unfortunately your 401k also has required minimum distributions thanks to it being funded by pre-tax dollars. The calculation is exactly the same as with the Traditional IRA. There is one caveat with 401ks: if you still work for the company sponsoring your 401k and own less than 5% of that company you are not required to take a distribution.
Get Required Minimum Distribution Calculation Help. The Financial Industry Regulatory Authority provides a handy calculator for Required Minimum Distributions. Always double check with the IRS worksheets to insure the calculations are completed correctly.
Another Benefit of Roth IRAs: No Required Minimum Distribution
If you’re reading this blog, you are interested in learning more about Roth IRAs. You’re trying to determine if this type of retirement account would be a good financial move for you and your family. So why go to all the trouble to talk about ages that you have to begin taking money out of those accounts, and running through calculations that don’t apply to the Roth IRA? Because that’s the point. The Roth IRA is a beautiful investment vehicle. Yes, you pay taxes today on the funds you invest. But you never pay taxes on those funds when you withdraw them. And you’ve never forced to withdraw them at all!
There’s no additional math needed when you are looking at the value of your investments inside the Roth IRA. If it says you have $1,000,000 for retirement, you do. You’re done. It’s that simple. You don’t have to sit and think, okay, so take out taxes off that amount and I really have $750,000. You don’t have to look up life expectancy tables to figure out how much money you have to withdraw. This is one of the key benefits to Roth IRAs in my eyes. I pay my taxes now, I assume taxes are going to go up eventually, and I know that my account balance is my actual account balance. I have the freedom to decide when or if those funds ever come out of the Roth IRA during my lifetime. It’s a fantastic retirement choice.