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Tax-advantaged retirement accounts like 401(k)s and traditional IRAs have their perks. Both allow you to build your nest egg while reducing your taxable income during your working years—but you can't avoid paying taxes forever. When you're ready to tap those funds, withdrawals will be taxed as ordinary income. Most folks are also required to begin taking required minimum distributions (RMDs) from tax-deferred accounts when they turn 72. This prevents account holders from dragging their feet when it comes to paying taxes.
RMDs can affect your income strategy and tax liability in retirement. Failing to plan ahead could result in unwanted financial surprises. Here's how required minimum distributions work, how they're taxed and what happens if you don't take them.
How Required Minimum Distributions Work
If you're making tax-deductible contributions to a retirement account, you'll eventually have to take RMDs when the time comes. The same goes for retirement accounts that are funded with pretax dollars. A 401(k) is a great example. Your contributions are taken straight from your paycheck before you pay taxes on that money. This effectively lowers your taxable income today.
RMDs apply to the following accounts:
It's worth noting that Roth IRAs have unique RMD rules. These retirement accounts are funded with after-tax dollars. That means you can make withdrawals whenever you like, penalty- and tax-free, as long as you've had the account for at least five years.
However, things are different for beneficiaries who inherit a Roth IRA. Folks in this camp must take RMDs after the original account holder's death, though younger beneficiaries are able to take smaller distributions over a longer period of time. That gives their funds more time to benefit from tax-free growth.
When Do I Have to Start Taking Required Minimum Distributions?
If you turn 70½ on or after January 1, 2020, you must begin taking RMDs by April 1 the year after you turn 72. Folks who hit that birthday prior to 2020 must have started taking RMDs at 70½.
How Much Do I Have to Withdraw?
The IRS has a specific formula for calculating the amount of required minimum distributions. For each account, you divide the prior December 31 balance by an IRS life expectancy factor. There are three different charts to choose from, depending on your situation.
- Single Life Expectancy Table I: You're the beneficiary of an inherited IRA.
- The Joint and Last Survivor Table II: Your spouse is the sole beneficiary of the account and they're more than 10 years younger than you.
- Uniform Lifetime Table III: Your spouse is not your sole beneficiary or they're not more than 10 years younger than you.
Let's say the prior year-end account balance for your traditional IRA was $200,000. You just turned 72 and your spouse, who is 68, is the sole beneficiary of your account. In this case, you'd use the Uniform Lifetime Table III, which shows your life expectancy factor as 27.4. Your required minimum distribution would be $7,299 ($200,000 divided by 27.4).
How Are RMDs Taxed?
Once you determine how much you're required to withdraw and start taking RMDs, your distributions will be taxed at your current income tax rate. This amount is determined by your income and tax filing status.
|2022 Federal Tax Brackets by Taxable Income|
|Tax Rate||Unmarried||Head of Household||Married Filing Separately||Married Filing Jointly|
|10%||$0 - $10,275||$0 - $14,650||$0 - $10,275||$0 - $20,550|
|12%||$10,276 - $41,775||$14,651 - $55,900||$10,276 - $41,775||$20,551 - $83,550|
|22%||$41,776 - $89,075||$55,901 - $89,050||$41,776 - $89,075||$83,551 - $178,150|
|24%||$89,076 - $170,050||$89,051 - $170,050||$89,076 - $170,050||$178,151 - $340,100|
|32%||$170,051 - $215,950||$170,051 - $215,950||$170,051 - $215,950||$340,101 - $431,900|
|35%||$215,951 - $539,900||$215,951 - $539,900||$215,951 - $323,925||$431,901 - $647,850|
|37%||$539,901 or more||$539,901 or more||$323,926 or more||$647,851 or more|
Let's say you're married, filing jointly and your combined income with your spouse is between $83,551 and $178,150. That puts your tax bracket at 22%. Returning to the example from earlier, let's assume an RMD of $7,299. Your tax liability on that distribution would be $1,606 ($7,299 multiplied by 0.22). Again, if you're taking distributions from a Roth IRA, you won't be taxed at all.
What Happens if You Don't Take Your RMD?
The penalty for not taking your RMD on time or withdrawing too little is pretty steep: The amount not withdrawn will be taxed at 50%. You'll also be expected to file IRS Form 5329 with your federal tax return for that year.
You might be able to waive the penalty if you can establish that the mistake was due to a reasonable error and that you're taking steps to remedy the situation. In this case, you'll file the same tax form along with a letter of explanation.
The Bottom Line
Staying on the right side of the IRS is always recommended. This includes taking your full RMD on time every year. Failing to do so could result in a penalty that takes a significant bite out of your nest egg.
Understanding how it all works can help you get the most out of your retirement income. Experian is here for you along the way, allowing you to check your credit score and credit report for free whenever you need it. It's a simple way to keep your financial health strong as you work toward retirement and beyond.