What are required minimum distributions and how do they work?

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Required minimum distributions (RMDs), are mandatory annual withdrawals required from individual retirement accounts (IRAs) or employer-sponsored retirement plans in order to be in keeping with United States tax laws. 

An RMD amount is calculated by dividing one’s tax-deferred retirement account balance as of December 31 of the prior year by one’s life expectancy factor. Let’s deep dive into what you need to know about how taking required minimum distributions (or RMDs) from your IRA works. 

In this video, Joe DiDomenico, Founder of WealthFlex, explains why minimum distributions are required, the penalty for missing an RMD, and the rules surrounding inherited RMDs.

Why are RMDs required?

The spirit of the IRA opportunity in the United States is to encourage taxpayers to save for retirement. It’s widely recognized that Social Security by itself won’t be able to sustain an adequate lifestyle for most people through retirement. Tax advantages were created for people who put money away for their future. The idea was not to allow people to pay less taxes in general, but only to pay less taxes if their activity and behavior was consistent with the goal to save for retirement. Please note that Roth IRAs are not included in this RMD discussion.

The entire point of having a retirement account is that the money should eventually leave the tax-advantaged account and be spent during retirement. The story, according to the United States treasury, goes like this: You develop as a child to become a productive member of our economy by earning, spending, and paying taxes. You save along the way so when you can’t actively earn anymore, you can still spend, then you die a quick inexpensive death, or a slow expensive one if you have enough money or private insurance.  

With this in mind, you can see why the treasury imposes a required minimum distribution amount of your retirement account value each year over the age of 72. The amount is based on statistical life-expectancy numbers. If you fail to meet this required amount of distribution, the penalty is 50% of the deficit amount.  

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What is the penalty for missing an RMD?

Say for example that you are in the 37% tax bracket. After you pay your 50% penalty on the missed amount and the 37% income tax on that amount, you are left with 13% of your money.  In a scenario like this, you would have been better off having never put the money in your IRA to begin with. 

Penalty for missed RMD

(50% of RMD amount) + (37% for Income Tax) → Only 13% left 

The amount of your RMD is a calculation considering all of your non-Roth IRAs and retirement accounts. So in turn, you are able to take the RMD evenly amongst your accounts, or all of it from a single account. That part is up to you. Also, you are allowed to take in-kind distributions to meet your RMD if your custodian allows it. This means distributing assets that have a combined value of at least the RMD amount.  

If you miss your RMD, you should report this on your taxes and either pay the excise tax or request a waiver. If you request a waiver, you don’t need to pay the excise tax at the time, but rather wait for a response from the IRS. Take a distribution of the amount of the missed RMD as soon as you can, and you will be informed whether it will count towards your current RMD or your past RMD. Definitely talk to your tax advisor on this issue if this happens to you.

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What happens with RMDs for inherited IRAs?

Another RMD issue to consider is the inheritance of an IRA. If you are inheriting an IRA from your spouse or are inheriting an IRA while disabled or chronically ill, you can treat the inherited IRA as your own. Other IRAs not inherited from spouses or if you are not disabled or chronically ill, have an RMD that is factored over 10 years. 

In the interest of avoiding RMD-related complications, it is recommended that IRA holders take the required amount of money out when they are supposed to and enjoy it. 

Please note, Yieldstreet cannot provide tax advice, please consult a tax professional for advice specific to your situation. Learn more about how you can take retirement planning to the next level with a Yieldstreet IRA. Contact us at [email protected] with any questions.

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