To avoid tax penalties at a time when you can least handle it in retirement, it’s crucial to properly figure out your minimum individual retirement account (IRA) distribution or your required minimum distribution (RMD). Usually, a traditional IRA RMD triggers at age 70 ½ under federal tax law. However, for a Roth IRA there is no RMD. The RMD amount that applies is specified by Internal Revenue Service (IRS) rules, but there’s no need to panic because the IRS is involved. Their rules are rather easy to understand.
What is My RMD Balance?
Your RMD amount is dependent on what you ultimately have in your IRA in terms of money balance. The IRS usually treats all of your pre-tax IRAs as one pre-tax IRA. Thus, you don’t get to avoid an RMD on other accounts just because you withdrew from one account. You must figure out your total balance from all of your accounts by looking at your most up-to-date account statements when you turn 70 ½. If you want to play it safe and follow the IRS instructions, you could do crunch the calculation using age 70 instead. However, your calculations will be off by a smidgen depending on much six months of interest and profits are generated in the meantime.
What is the Fair Market Value?
You must use the fair market value of your IRA account as the account value. The IRS does not allow you to use anticipated investment value or net deposit worth for a minimum figure. But don’t forget that you can always take out more than the required RMD figure calculated. Your base account total must be what the fair market value is as of Dec. 31 of the year you turn 69, i.e., the year before you are 70 ½ years of age.
What is the Rate of Return?
The next step involves determining what the rate of return will be on your IRA account. By this time, most folks will be using safe investment tools such as bonds, CDs, and savings accounts. The great thing is that all of these financial instruments have fixed interest rates, so the calculation just involves basic business math. However, for those folks who have IRAs in the stock market, they will have to make a best guess on their rate. The trick is to guess conservatively to ensure that you take out enough in your RMD. Thus, if you think that the stock market will return 5 percent, then calculate 7 percent to be safe for the tax rules.
It’s Your Birthday
Boy, does your birthday get important now! If your birthday falls before June 30 in a year, your first RMD is at age 70. However, if your birthday lies between July 1 and Dec. 31, your first RMD will be at age 71. The net result is that this reduces your total number of years with an RMD. Thus, if you originally had 26 years of estimated life, you would now have only 25 years of estimated life for tax purposes.
The Final Calculation
You begin by using your total IRA account balance, and then you divide it by the correct distribution period for your situation per IRS Publication 590. Take that result, and use it for your RMD. For example, if your account was worth $100,000 with 25.6 years, it would require an RMD of $3,097. Of course, you will need to adjust this every year after your first RMD due to any other account profits and your rate of return.
UMB.com: article: “How to Determine your RMD”
Bankrate.com: article: “Know your Required Minimum Distribution”
U.S. Internal Revenue Service: manual: “Publication 590″
AARP RMD Calculator
Investopedia: article: “Strategic Ways to Distribute Your Retirement”