Why Are There RMDs or Required Minimum Distributions?
Required minimum distributions, or RMD, is the minimum amount you must withdraw from certain retirement accounts each year. To understand why there are RMDs, it helps to look at things from the government’s perspective.
The government runs by collecting tax dollars. However the government also encourages certain behaviors in its citizens and companies by permitting certain tax breaks. (One behavior this encourages is big donations to politicians by companies to get and preserve tax breaks, but that is a topic for another day.) One behavior the government tries to encourage is getting people to save for retirement. It does this by providing several tax-advantaged accounts taxpayers can use to save for retirement, including 401k plans, IRA accounts, and Roth IRA accounts.
In all three of these accounts, the interest, earnings, and capital gains are exempt from taxes each year so long as the money stays in the account. Not paying taxes is the incentive to save for retirement. If you do take the money out of the account before you turn 59 1/2 years old, then you have to pay a 10 percent tax penalty. That is the incentive to not take the money out for something besides retirement.
But, what about when you actually retire?
There is a lot of money out there in 401k plans and IRA accounts. Some estimates suggest that there is now, or will be soon, TRILLIONS of dollars in such accounts. The government wants you to save for retirement, but they don’t necessarily want to give up that much tax revenue either. So, when you do retire and start using that money, you pay taxes on the withdrawals.
However, there is a catch. If you happen to retire in a way that you don’t need the money in your IRA or 401k account, then you might not withdraw it at all. That means you wouldn’t pay taxes on that money, and with generous estate tax rules, and beneficiary rules for retirement accounts, the government might never get to tax that money. To prevent this scenario the IRS rules for required minimum distributions compel taxpayers to withdraw at least SOME money from these types of retirement accounts once they turn 70 1/2. That way, they get to start taxing at least some of the money.
The amount of RMD is based on actuarial tables, meaning you have to take a larger percentage each year as you get older.
Calculate RMD Amount
To calculate the RMD amount, you use tables in IRS Publication 590, which determine the percentage of required minimum distribution you must take. The IRA required minimum distribution table is the same as the 401k required minimum distribution table.
The easiest way to calculate, however, is to use an online RMD retirement calculator. To use the calculator, input your account balance from December 31st of the year you are calculating the RMD for. Then, input your age and you’ll get the required amount to withdraw.