If you are age 72 or older, you are required to take at least a minimum withdrawal from your tax-deferred retirement accounts every year, whether you need the money or not.
Why? The federal government wants its share.
Tax-deferred retirement accounts, such as 401(k)s and traditional IRAs, are funded with pretax dollars, yielding an immediate tax deduction in the year you contribute. They also provide the opportunity to potentially produce higher long-term returns through compounded growth, since earnings are not taxed until you distribute funds from your account.
But you can’t leave those dollars untaxed forever.
The Internal Revenue Service requires you to begin taking a required minimum distribution, or RMD, from your tax-deferred retirement account every year after you reach 72, the new age limit under the SECURE Act. (If you were born before July 1, 1949, the age at which RMDs must begin is still 70½.) (Learn more: 3 points to know about the SECURE Act)
For your first distribution, you have until April 1 after the year in which you turned 72 to take your withdrawal. For all subsequent years, you must take your RMD by December 31. You can always take more than the required minimum if you choose, but any excess distribution beyond the required minimum cannot be applied to the RMD for a future year. (Required minimum distribution calculator)
Distributions from tax-deferred accounts are taxed at your ordinary income tax rate, which caps out at 37 percent for the highest income households in 2022, rather than the capital gains tax rate for earnings on most assets held for more than a year, which caps out at 20 percent.
Failure to take your full RMD from a tax-deferred account by the required deadline results in a hefty penalty: the amount not withdrawn is taxed at 50 percent. According to the IRS, however, that penalty may be waived if the account owner establishes that the distribution shortfall was due to a “reasonable error” and that reasonable steps are being taken to correct the error.
Which accounts do RMDs affect?
RMDs apply to all employer-sponsored retirement plans, including profit-sharing plans, 401(k)s, 403(b)s, and 457(b) plans, as well as traditional IRAs and IRA-based plans, such as SEP IRAs, SIMPLE IRAs, and SARSEPs.1
The amount of your RMD is determined by your projected life expectancy and the size of your account.
Be aware that mandatory RMDs, when taken during a bear market, can significantly reduce your retirement savings. For example, a 74-year-old investor whose IRA assets were valued at $500,000 at year-end 2021 would have to take a $19,607 RMD in 2022. Had that investor taken their distribution on Jan. 1, 2022, before the markets fell, their account would have been left with $480,393. By waiting until the fall of 2022 to take their RMD, however, when the average retirement portfolio value (based on an allocation of 60 percent stocks and 40 percent bonds) was down roughly 25 percent, their IRA value would be worth $360,295, according to an analysis by Barron's.
Use the appropriate IRS worksheet to calculate your current year RMD yourself.
Or, the federal government provides an RMD calculator to help estimate your annual required minimum distribution. According to the calculator, a taxpayer aged 75 with a balance of $250,000 in their traditional IRA would be required to withdraw roughly $10,200 from their account in 2022.
If you have more than one tax-deferred IRA, you must calculate your RMD separately for each account, but you may take your minimum distribution from one or more accounts. The same is true for 403(b)s. Taxpayers who own other types of tax-deferred accounts, however, including 401(k)s and 457(b) plans, must take RMDs separately from each of their plan accounts, according to the IRS.2
Potential tax implications of RMDs
Depending on the balance in your tax-deferred accounts and your other sources of retirement income, including pensions and Social Security, the distributions you receive could conceivably bump you into a higher tax bracket. It could also potentially trigger higher taxes on your Social Security benefits and an additional high-income surcharge on your Medicare benefit.
In particular, those taking their RMD for the first time at age 72 should be aware of the potential tax implications of their withdrawal strategy.
For example, those who wait to take their first RMD until April 1 of the following year, as they are permitted to do for their first withdrawal, would also be required to take their second withdrawal by December 31 of that same year – which could potentially trigger higher taxes that year.
To mitigate their tax hit in retirement, some pre-retirees choose to begin withdrawing money from their tax-deferred accounts after they turn age 59½. (Any earlier and they would face an early withdrawal penalty.) They would still owe ordinary income tax on the distributions, but the withdrawals would slowly reduce the balance in their tax-deferred accounts, which could result in a smaller RMD when they turn 72.
That strategy yields another important potential benefit too: It may enable you to delay claiming Social Security beyond your full retirement age, which permanently increases the size of your monthly benefit. (Learn more: Filing for Social Security retirement benefits)
Another way to potentially offset a future tax bump when RMDs kick in is to convert a portion of your tax-deferred accounts to a Roth IRA early in retirement when your tax rate may be lowest. While income limits exist for Roth IRA contributions, there are no income limits for conversions.3
Be aware that when you convert to a Roth IRA, you will owe taxes upfront on the amount you distribute from your tax-deferred account (contributions and earnings), which can amount to a sizable bill. The earnings in a Roth IRA going forward, however, will grow tax free, and your account will not be subject to RMDs, so it can continue to potentially deliver returns for longer. From an estate planning perspective, Roth IRAs can also be potentially passed along to your heirs.
Such moves, however, may not be appropriate for everyone. It is important to consult a tax advisor or financial professional to help weigh the pros and cons of any strategy that could affect your financial security.
Taking your RMD
How you use your RMDs is up to you. You can spend it on current living expenses, save it, invest those dollars to chase potential stock market returns, pass it along to your heirs, or treat your family to an all-expenses paid vacation.
If you have enough savings that you truly don’t need your RMD to pay for living expenses, you might also consider donating all or part of your distribution to a favorite charity. The government allows taxpayers to gift up to $100,000 from their IRAs to a qualified charity tax free each year.4 The donation goes to a good cause, and the RMD does not get included in your taxable income.
Some investors also choose to be tactical with their RMDs, using their annual withdrawals to sell off portions of their portfolio that are underperforming or no longer align with their investment goals.
As with most things involving retirement planning, it is important to work with a financial professional who can help guide you in making the best decisions for your financial situation.
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1 Internal Revenue Service, “Retirement Plan and IRA Required Minimum Distributions FAQs,” Sept. 23, 2022.
2 Internal Revenue Service, “Retirement Plan and IRA Required Minimum Distributions FAQs,” Sept. 23, 2022.
3 Internal Revenue Service, “IRA FAQs – Rollovers and Roth Conversions,” June 16, 2022.
4 Internal Revenue Service, “Publication 590-B (20219, Distribution from Individual Retirement arrangements (IRAs). April 25, 2022.”