In this article, we're going to discuss minimum required distributions, or MRDs. For certain retirement accounts, including the 401(k), 403(b), and the Traditional IRA, minimum distributions are required. Here we'll discuss the calculation of this distribution, and the exact MRD rules to follow.
What is a Minimum Required Distribution?
The purpose of a minimum required distribution is to make sure taxpayers actually use their retirement money, and not leave it behind as part of their estate. The Internal Revenue Service monitors these minimums to make sure the money in an Employer Sponsored Retirement Plan or ERSP such as a 401(k) plan or 403(b) account is used for retirement, and not earmarked to be inherited by others.
Traditional IRAs are also subject to minimum required distribution rules; however, with Roth IRAs minimum distributions are not required. The reason Roth IRAs do not have a MRD is quite simple: income taxes. The money withdrawn from a 401(k), 403(b), and the tax-deferred portion of a Traditional IRA is subject to federal income taxes. Roth IRA withdrawals, or qualified distributions, are not subject to this tax. The federal government would like to collect this income tax, and by creating a MRD, it is removing a potential tax shelter. If this did not occur, the money left in these retirement accounts would pass on to the owner's heirs, and the inheritance tax laws could allow the money to pass to heirs tax-free.
MRD Rules
Under most employer sponsored plans, individuals must take their first minimum withdrawal from their account by April 1st of the year following the year that they reach age 70 1/2. Anyone delaying taking their first MRD until April 1st must take their second MRD by December 31st of that same year.
Exceptions to the MRD Rules
Individuals age 70 1/2, that are still working, and not a 5% owner of their employer, may not be required to take a minimum required distribution. This exception applies as long as they remain working. A second exception to the MRD rule may also apply if an individual participated in a 403(b) plan prior to December 31, 1986. In that case, the plan may allow accountholders to defer taking a minimum distribution until age 75.
Tax Penalties
It's important to understand these MRD rules because not taking a distribution can be costly. The IRS can impose a 50% tax penalty on any amount that should have been withdrawn via a minimum required distribution. That 50% tax penalty is in addition to the "regular" federal income tax due on the distribution.
The IRS can impose a 50% tax penalty on any amount that should have been withdrawn via a MRD in addition to the "regular" federal income tax due on the distributionMoneyzine Editor
Revised Rules
Back in April 2002, the IRS revised the minimum required distributions for IRAs, 401(k) accounts, and 403(b) plans. These rules first became effective in January 2003. These new rules revised the life expectancy tables previously used, essentially extending the life expectancy factor and thereby modifying the MRD calculation. By increasing the life expectancy factor, retirement accountholders were required to take smaller distributions.
Excess Distributions
Keep in mind this is a discussion of the minimum distributions. There is nothing to prevent anyone from taking more than the minimum. However, an individual that takes more than the minimum in one year does not get a "credit" in subsequent years. The calculation of a MRD does not allow for such credits. Finally, rollover rules do not apply to MRDs. These distributions cannot be rolled-over into another retirement plan.
MRD Calculations
In general, the minimum required distribution is calculated by dividing the market value of the tax deferred retirement money as of December 31st of the prior year by the individual's life expectancy factor taken from the proper IRS table.
Example MRD Calculation
Let's say that the market value of the tax deferred portion of Joe's IRA is $100,000, and he is 76 years old. Using the Uniform Lifetime Table, the calculation of his MRD is: = Market Value of Deferred IRA / Distribution Period Factor Or $100,000 / 22 = $4,545.45 If a spouse or beneficiary is more than 10 years younger than the accountholder, then the Joint Life Expectancy Table is used when calculating an MRD. The factors found on this table will result in smaller distributions relative to the Uniform Lifetime Table. We offer a minimum required distributions calculator that can be used to run through additional examples.
Additional Resources
- A comprehensive retirement plan will have a mix of employer benefits, government plans, and retirement savings accounts. There are also many "rules of thumb" that prescribe how much income is needed once retired. From a practical standpoint, retirement income needs to last a lifetime, which might be longer than most people think. In this article, we're going to first start out by talking a little bit about life expectancy, and separate some of the fact from fiction. Next, we'll talk about retirement income, in depth, including how to go about calculating how much money is needed. We'll also talk about...Moneyzine EditorOctober 4th, 2023
- To many of us, the ultimate measure of a successful career was to retire a millionaire. But it takes more than just dreaming, and a big salary, to retire with that much money. It takes discipline and time.Moneyzine EditorOctober 4th, 2023
As workers approach their peak earning years, many begin to think about questions like "When is the best time to retire?" We hear stories all the time about people living longer, which is good news. Individuals still thinking about retiring at age 62, need to figure out if their retirement plans are taking this new information into account.Moneyzine EditorNovember 20th, 2023
There was a time when retiring with a mortgage was unthinkable. Making that last payment was something to celebrate, and that achievement was shared with family and friends. There was even a name for those celebrations; they were called mortgage-burning parties.Moneyzine EditorNovember 20th, 2023
Retirees that want to enjoy a richer lifestyle should give serious thought to tapping into their home's equity using a reverse mortgage. For many Americans, the single most valuable asset they own is their home, and reverse mortgages allow seniors to generate a steady stream of income. In this article, we're going to help answer the question: What is a reverse mortgage? We're also going to explain how these loans work, and discuss the different offerings on the market today. Finally, we're going to finish up with some information on how they're calculated, their income tax treatment, and the costs...Moneyzine EditorNovember 20th, 2023
