How RMDs Are Calculated
The annual RMD is calculated by dividing the retirement account balance as of December 31 of the previous year by a life expectancy factor provided in IRS tables.
The basic formula is: RMD = Prior Year-End Account Balance ÷ IRS Life Expectancy Factor. For most account owners, the IRS Uniform Lifetime Table is used. Special rules apply when a spouse is the sole beneficiary and is more than 10 years younger than the account owner.
For example, suppose your December 31 account balance is $500,000 and the IRS life expectancy factor is 26.5. Your RMD would be $500,000 ÷ 26.5 = $18,868.
In this example, the retiree would be required to withdraw at least $18,868 for the year. The actual factor used depends on the individual's age and circumstances.
Special Rules for Still-Working Employees
Employees who continue working beyond age 73 may be able to delay RMDs from their current employer's retirement plan until they retire if the plan permits. However, this exception does not apply to traditional IRAs, SEP IRAs, or SIMPLE IRAs, which generally require RMDs once the applicable age is reached.
Penalties for Missed RMDs
Failing to take the full RMD can result in a substantial IRS excise tax penalty. The RMD penalty is generally 25% of the amount that should have been withdrawn. The penalty may be reduced to 10% if the error is corrected within the prescribed correction period and certain IRS requirements are met. For example, if your RMD for the year is $20,000 but you withdraw only $12,000, the shortfall is $8,000. In this case, the potential penalty would be $2,000 (25% of $8,000).
In addition to any penalty, you must withdraw the remaining $8,000. You may also be required to file IRS Form 5329 to report the missed distribution and, if eligible, request a waiver or reduction of the penalty.
Tax Impact of RMDs
For most traditional retirement accounts, RMDs are taxed as ordinary income in the year they are received. Large RMDs can increase adjusted gross income, adding to the retiree's taxable income and impacting federal income taxes, state income taxes (where applicable), Medicare premium surcharges (IRMAA), and taxation of Social Security benefits. Because RMDs can increase taxable income, proactive planning is important and reviewing income sources several years before RMDs begin can help minimize surprises.
Planning Opportunities
Coordination with a financial planner and tax advisor can help retirees understand the applicable rules well before RMDs begin, manage income more deliberately, preserve wealth, and avoid unnecessary tax consequences.
Some retirees intentionally draw down tax-deferred accounts before RMD age to manage future tax brackets and reduce future mandatory distributions. If you are charitably inclined, you can transfer funds directly from your IRA to an eligible charity. These qualified charitable distributions (QCDs) count toward satisfying your RMD without being included in your taxable income. You can make QCDs as early as age 70 ½ up to an annual limit of $111,000 (meaning married couples can donate up to $222,000 total if both have separate IRAs).
RMDs and the Housing Allowance
If you’re an ordained clergy person who is an MMBB member, keep in mind that RMDs may be designated as housing allowance eligible for clergy. This means the RMD may not be fully taxable for federal income tax purposes if the member can substantiate eligible housing expenses and the amount does not exceed the applicable housing allowance limits. Any portion of the RMD that exceeds the allowable housing allowance amount must be reported as taxable income. Make sure to retain housing expense records and consult a tax professional familiar with clergy taxes about the relationship between RMDs and the housing allowance.
Next Steps
If you are approaching RMD age, review your retirement accounts, projected taxable income, charitable giving plans, and withdrawal strategy with a financial planner and tax professional before your first required distribution is due. Remember, MMBB members can access an MMBB financial planning specialist at no additional cost as a benefit of membership.
The information contained herein is for informational purposes only. While MMBB made every attempt to ensure that the information is accurate, MMBB is not responsible for any errors or omissions or the results obtained from the use of this information. MMBB is not liable for any success or failure that is directly or indirectly related to the use of the information contained herein. The information contained herein does not constitute any financial, insurance, investment, legal, or tax advice. The inclusion of any third party links does not constitute an endorsement. In no event shall, MMBB and/or its fiduciaries, directors, officers, employees, or agents thereof be liable for any special, direct, indirect, consequential, or incidental damages or any damages whatsoever, whether in action of contract, negligence or tort, arising out of or in connection with the use of the information contained herein.
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