While it might be a while before you begin taking distributions from a retirement account, there are important rules you should factor into your planning, no matter your age. Find out what retirement RMDs are, how they affect different types of retirement accounts, and 6 distribution rules every investor should know.
Ray B. says, "I’ve been a weekly Money Girl listener for many years and appreciate the thoroughness of your podcast. I was reading today that Roth 401k accounts are subject to RMDs while Roth IRAs are not. I thought all Roth accounts were exempt from RMDs, what have I missed?”
Thanks for being a loyal podcast listener and for your question, Ray. RMDs, or required minimum distributions, on retirement accounts can be confusing. If you don’t follow them, either because you don’t want to comply or you just don’t know the rules, the penalty is surprisingly high.
While RMD rules don’t affect you until later in life, young people should get familiar with them, too. The policies for taking distributions from retirement accounts should be factored into your planning to build wealth, no matter your age.
In this post, I’ll explain what RMDs are and how they affect different types of retirement accounts. You’ll learn six of the most important rules about taking distributions that everyone should know.
6 Important Retirement RMD Rules Investors Should Know
- Only a Roth IRA has no RMD for the owner.
- Retirement plans at work have RMD exceptions.
- Your RMD amount changes every year.
- Multiple accounts can be subject to different RMD rules.
- You can use rollovers to your advantage.
- Not complying with RMDs is expensive.
We’ll review exactly what RMDs are and what you need to know about each of these important rules for retirement accounts.
What Are Required Minimum Distributions (RMDs) for Retirement Accounts?
Required minimum distributions are annual minimum amounts that you typically must withdraw from a retirement account starting the year you reach age 70½. They continue for the rest of your life or until an account is depleted.
The purpose of an RMD is to make sure you eventually pay tax on amounts that weren’t previously taxed. Payouts are subject to your ordinary income tax rate, not the capital gains rate, which gets applied to investment profits outside of retirement accounts.
You can take out more than the minimum, but failing to withdraw what’s required each year results in stiff penalties. There are a few exceptions, which I’ll cover in a moment.
Here’s a summary of six important retirement RMD rules you should know:
1. Only a Roth IRA has no RMD for the owner.
You must take RMDs from traditional, tax-deferred accounts that you own as an individual, a business owner, or through an employer, including a:
- Traditional IRA
- Self-employed plan, such as a SEP-IRA, SIMPLE IRA, and solo 401(k)
- Plan through an employer, such as a 401(k), 403(b), and 457
- Profit sharing plan
- Employee stock ownership plan (ESOP)
- Federal Thrift Savings Plan (TSP)
Additionally, Roth accounts at work, such as a Roth 401(k) or Roth 403(b), are also subject to RMDs. That’s what Ray asked about at the top of this post.
Because you own a Roth at work, the rules require you to take RMDs. However, since you make after-tax contributions to a Roth, withdrawals of contributions and earnings from a workplace Roth or a Roth IRA are always tax-free.
But a Roth IRA is unique because it’s the only account that has no RMD while the original owner is alive. This exception allows you to keep money you don’t need growing tax-free for your heirs. But after your death, beneficiaries who inherit your Roth IRA must comply with RMD rules.
2. Retirement plans at work have RMD exceptions.
If you have a retirement plan at work, such as a 401(k) or 403(b), there’s an important RMD exception to know. If you’re not ready to retire by age 70½ and are still working for an employer where you have a retirement plan, you don’t have to take RMDs.
Whether you need to keep earning income or simply enjoy your job, it’s becoming more common to keep working past age 70½. As long as you don’t own more than 5% of the company where you work, you can generally delay the requirement to take distributions from a traditional or Roth workplace plan until you finally retire.
In some cases, the rules may allow you to still be considered employed for the purposes of this exception, even if you’re working part time. Check with your retirement plan administrator to understand what’s allowed.
Also note that the still-working exception doesn’t apply to any other type of retirement plan for individuals or the self-employed, such as a traditional IRA or a solo 401(k), or retirement accounts you have with previous employers.