Required Minimum Distribution (RMD): Definition and Calculation

What Is a Required Minimum Distribution (RMD)?

A required minimum distribution (RMD) is the amount of money that must be withdrawn from an employer-sponsored retirement plan, traditional IRA, SEP, or SIMPLE individual retirement account (IRA) by owners and qualified retirement plan participants of retirement age.

In 2023, the age at which you must begin taking RMDs changed to 73 years. Account holders must therefore start withdrawing from a retirement account by April 1, following the year they reach age 73. The account holder must withdraw the RMD amount each subsequent year based on the current RMD calculation.

Another significant change from Secure 2.0: Starting in 2024, holders of designated Roth 401(k) accounts will no longer be required to take RMDs from them (during their lifetime). This rule is already true for Roth IRAs.

Understanding Required Minimum Distributions (RMDs)

A required minimum distribution (RMD) acts as a safeguard against people using a retirement account to avoid paying taxes. RMDs are determined by dividing the retirement account’s prior year-end fair market value (FMV) by the applicable distribution period or life expectancy.

The Internal Revenue Service (IRS) has a worksheet to help taxpayers calculate the amount they must withdraw. Generally, your account custodian or plan administrator will calculate these amounts and report them to the IRS.

Some qualified plans allow certain participants to defer the start of their RMDs until they actually retire, even if they are older than age 73. Qualified plan participants should check with their employers to determine whether they are eligible for this deferral. In general, this applies to plans at the workplace where they are currently employed, not to IRAs or qualified plans from previous employers.

It should be noted that while an account holder must withdraw the RMD amount, they can also withdraw above that amount. If the account holder wants to withdraw 100% of their account in the first year, that’s perfectly legal, but the tax bill could be a bit of a shock.

How to Calculate RMDs

The account custodian should be able to tell you the RMD for the account held there. However, you can also calculate what you owe on your own. When calculating your RMD for any given year, it is always wise to confirm on the IRS website that you are using the latest calculation worksheets. These tables are updated to reflect changes in life expectancy.

Different situations call for different calculation tables. For example, IRA account holders whose spouse is the account’s only beneficiary and more than 10 years younger than the account holder use a different table than other account holders.

For traditional IRA account holders, the RMD calculation involves three steps:

1. Write down the account’s balance as of Dec. 31 of the previous year.
2. Find the distribution factor listed on the calculation tables that corresponds to your age on your birthday for the current year. For most people, this factor number ranges from 27.4 down to 1.9. As a person gets older, the factor number goes down.
3. Divide the account balance by the factor number to find the RMD.

Example of an RMD

Each year's RMD must have been withdrawn from the relevant retirement savings account(s) by Dec. 31. Account holders may withdraw their funds periodically throughout the year or wait until the year's end to earn the maximum interest on their funds.

Here's an example. Bob, an account holder, turned 74 on Oct. 1, and his IRA was worth $205,000 on Dec. 31 of the prior year. To calculate the annual amount to be withdrawn, the prior Dec. 31 balance is divided by the distribution factor from the relevant IRS table. In the case of Bob, that means dividing $205,000 by 25.5, which is the distribution period from the latest Uniform Lifetime Table for a 74-year-old. There are other tables for beneficiaries of retirement accounts and account holders with much younger spouses.

$\begin{aligned}\text{RMD}=\frac{\$205,000}{25.5}=\$8,039.21\end{aligned}$RMD=25.5$205,000​=$8,039.21​

Divide $205,000 by 25.5, and you get $8,039.22. That's the minimum amount Bob needs to withdraw from his retirement account that year to avoid a fine.

There are some other things Bob should keep in mind. Let's suppose Bob has multiple IRAs. This means the RMD must be calculated separately for each account. Depending on the types of accounts involved in this scenario, Bob may have to take RMDs separately from each account rather than all from one account.

Fortunately, retirement account holders don't always need to worry about calculating the minimum amount to withdraw each year. Generally, the custodian of the account can calculate your RMD for you. 

Special Case: Inherited IRAs

If you inherit an IRA, you will need to use the same RMD the account owner would have used for the year of the account owner's death. However, your RMD depends on your identity as the designated beneficiary for years following the account owner's death. For example, RMD rules may vary depending on whether you are a surviving spouse, a minor child, or a disabled individual.

Generally, if you inherit an IRA from an account owner who died before Jan. 1, 2020, you would calculate your RMD using the IRS Single Life Table. However, if the account owner died after Dec. 31, 2019, you'll need to follow the RMD rules established by the SECURE Act. These rules distinguish between eligible, designated, and non-designated beneficiaries. Therefore, the timeframe and calculation of your RMD can vary greatly depending on which of these categories you belong to as a beneficiary.

For example, some designated beneficiaries may be required to withdraw the entire account by the 10th calendar year following the year of the IRA owner’s post-2019 death. Meanwhile, some non-designated beneficiaries may be required to withdraw the entire account within five years of the IRA owner’s death. These rules effectively eliminate the stretch IRA, an estate planning strategy that some beneficiaries of inherited IRAs had used in the past to extend the tax-deferred benefits of an IRA.

The Bottom Line

Most people take withdrawals from their retirement accounts before the required minimum distribution (RMD) kicks in, will be living off their retirement funds, and, therefore, are very unlikely to be affected by not following these rules. The RMD is still important to understand and be aware of, though.

This rule is in place to prevent individuals from avoiding paying the deferred tax liability owed on their retirement contributions, kicks in at 73, is calculated by dividing the retirement account’s prior year-end fair market value by a life expectancy factor published by the IRS, and must be honored—a failure to abide results in a hefty 50% penalty.

Fortunately, the IRS publishes a worksheet that makes it very easy to calculate how much you must take out each year. However, other factors discussed in this article can catch people out, such as what to do with multiple IRAs or how RMDs work when the retirement account holder passes away and the funds are inherited.