What is an RMD?

If you’re getting closer to retirement age or already in retirement, you may have heard the term “required minimum distribution,” or RMD, in reference to your employer-sponsored retirement plan. But what exactly is an RMD?

Strictly speaking, a required minimum distribution is an amount of money that must be withdrawn each year from employer-sponsored retirement plans — e.g., a 401(k), 403(b), or 457(b) — by the plan participant once they reach a certain age or terminate employment, whichever comes later. Due to recent changes in legislation, that age is 73 for individuals born after 06/30/1949 and 70½ if born on or before that date.

RMDs exist to ensure that people do not accumulate tax-deferred retirement accounts and leave those funds as inheritance. They force the account holder to withdraw at least a portion of the money as distributions while alive. It’s important to note, though, that RMDs are not designed to provide guidance on how much you can or should take from your accounts.

The timing of RMDs

RMDs must be taken before December 31 each year, except for your first one. The year you reach age 73 (or 70½), you have until April 1 of the following year to take your initial RMDs out of your accounts. But be aware, if you wait to take the first RMD until the following year, you will have to take two RMDs the year you turn 73 (or 71½), potentially creating a large tax bill.

If you’re still working for the company that sponsors your 401(k) when you turn 73, you won’t need to start taking RMDs until April 1 of the year following your termination with that company, unless you own at least 5% of the company, in which case the normal rules still apply regardless of your working status.

How are RMDs calculated?

The RMD for any given account is calculated by taking the account balance as of December 31 from the year prior and dividing it by the account owner’s life expectancy, as determined by one of the IRS’s life expectancy tables. Details on these tables can be found on the IRS website, and the financial institution holding your account should be able to tell you what your RMD is each year.

You’ll repeat this process each year for all accounts subject to RMD rules. Once you’ve determined the dollar amounts that need to be distributed from each account, you’ll need to take a distribution of at least the RMD amount from the respective accounts to avoid penalty for that year. The tax penalty for not taking your RMD on any given year is 50% of the amount of the RMD.

However, there is some flexibility in these distributions. Within an employer-sponsored retirement plan with multiple sources of money, you can take your entire RMD amount from whatever combination of sources you would like, including post-tax or pre-tax sources. This gives you flexibility in your tax consequences when taking distributions from an employer-sponsored retirement plan, assuming there are pre-tax and post-tax dollars in the plan.

An RMD in action

Still not sure how RMDs work? Let’s look at an example. Say an employee terminates employment in 2024 and reaches age 73 in 2027. In this scenario, the employee must take their first RMD for the year 2027, and it must be taken by April 1, 2028, at the latest.

If their retirement plan balance is $100,000 on 12/31/2026, and if we use an IRS life expectancy factor of 27.4 (found on IRS website), then the 2027 RMD amount would be:

$100,000 ÷ 27.4 = $3,649.64

So the employee would need to take $3,649.64 out of their retirement plan by April 1, 2028. Let’s say they wait until January 2028 to take their first RMD. In this scenario, they would end up taking two RMDs in 2028: the 2027 RMD that they took in January, as well as the 2028 RMD that they will have to take before 12/31/2028. This potentially creates two taxable distributions for the year 2028. 

Consult the professionals

RMDs are a complex topic, and adding to that complexity is the fact that RMDs work somewhat different for individual retirement accounts (IRAs). Due to their complexity, it’s encouraged to contact a financial advisor or other qualified professional for detailed information about the RMD rules.