Understanding Required Minimum Distributions for Retirement Accounts
Using retirement accounts effectively is a smart strategy for saving. Not only does it help you build your retirement nest egg, but it also provides tax benefits. Accounts such as 401(k)s and traditional IRAs allow you to lower your taxable income when you make contributions. However, it’s essential to remember that tax obligations arise when you withdraw from these accounts during retirement.
To prevent individuals from postponing withdrawals to avoid taxes, the IRS mandates required minimum distributions (RMDs). If you are subject to RMDs now or will be soon, you may wonder if a withdrawal in May is advisable. The answer largely depends on your specific situation.
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How to Calculate Your Required Minimum Distribution
Your RMD represents the minimum amount you must withdraw from tax-deferred retirement accounts by December 31, starting at age 73. The only exception occurs in the first year, where you can wait until April 1 of the following year. You can calculate your RMD in three straightforward steps:
- Find your account balance at the end of the previous year.
- Consult the life expectancy factor (LEF) based on your age and marital status (provided by the IRS).
- Divide your account balance by your LEF.
For example, let’s consider a single individual with a retirement account balance of $500,000 as of the end of 2024:
| Age | Life Expectancy Factor | Required Minimum Distribution |
|---|---|---|
| 73 | 26.5 | $18,868 |
| 74 | 25.5 | $19,608 |
| 75 | 24.6 | $20,325 |
| 76 | 23.7 | $21,097 |
| 77 | 22.9 | $21,834 |
| 78 | 22.0 | $22,727 |
| 79 | 21.1 | $23,697 |
| 80 | 20.2 | $24,752 |
Data source: IRS. RMDs rounded to the nearest dollar.
Consequences of Not Taking Your RMD
Neglecting to take your RMD can lead to a penalty of 25% of the amount you did not withdraw. For instance, if a 75-year-old withdrew only $15,325 rather than the required $20,325, a penalty of $1,250 would apply (25% of the $5,000 shortfall).
Fortunately, if you correct this mistake and withdraw your RMD within two years, the penalty may be reduced to 10%. Continuing the previous example, if the 75-year-old makes the correction within two years, their penalty could drop to $500 (10% of the $5,000). Remaining informed about RMD obligations can help you avoid costly penalties.
Should You Withdraw Your RMD in May?
The advantage of RMDs is the flexibility regarding when to take withdrawals; as long as you complete them by the year’s end, timing is at your discretion. Some individuals opt to withdraw early in the year, while others wait until closer to the deadline or take incremental amounts throughout the year.
Ultimately, there is no perfect time for RMDs; it’s about what suits your financial needs. If you require immediate cash or prefer to avoid year-end stress, withdrawing in May may be practical. Conversely, if you are concerned about market volatility, delaying a larger withdrawal might be wise.
Market performance is unpredictable in the short run. This year has presented significant fluctuations, making it wise to consider spreading out RMD withdrawals throughout the year. Distributing these withdrawals can help mitigate the risk of selling investments at unfavorable prices during market downturns, which is a prudent strategy for retirees given current conditions.
Maximizing Social Security Benefits
If you find that you’re behind on retirement savings, some lesser-known “Social Security secrets” may help improve your retirement income. Understanding how to maximize your Social Security benefits could yield an additional $22,924 per year for many retirees. This additional income could significantly enhance retirement security and peace of mind.
The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.