Required Minimum Distributions: The Basics

The short version: Once you reach the applicable age, tax rules require you to withdraw a minimum amount from most retirement accounts each year. You must take it out and pay tax on it. You do not have to spend it.

Why the rule exists

Traditional retirement accounts let money go in before tax and grow without annual taxation. That is a genuine benefit and it was never intended to last forever.

Required minimum distributions are how the arrangement concludes. At a certain point the rules require money to start coming out, so that tax that was deferred is eventually paid.

Understanding that logic makes the requirement feel less arbitrary. It is the other end of a bargain you took the benefit of earlier.

What is generally covered

The requirement generally applies to traditional IRAs, SEP and SIMPLE IRAs, and most employer plans including 401(k) and 403(b) accounts.

Roth IRAs are treated differently for the original owner, which is one of the reasons they feature in planning conversations.

Inherited accounts have their own rules, and those rules have changed significantly in recent years. If you have inherited a retirement account, treat it as a separate subject rather than assuming it works like your own.

The applicable starting age has been revised more than once in recent years. Rather than quoting a figure that may not match your birth year, we would encourage confirming yours with a tax professional. It is a short question with a definite answer.

How the amount is worked out

In broad terms, the required amount for a year is based on the account balance at the end of the previous year, divided by a life expectancy factor published in tables issued by the IRS.

A larger balance produces a larger required amount. As you get older, the factor decreases, so the required proportion increases.

Your account custodian will generally calculate and report the figure for you, and most will tell you what it is early in the year. You should still know roughly what to expect rather than being surprised by it.

Where people get caught out

Several accounts, different rules

If you hold more than one IRA, the required amounts are generally calculated for each and may be taken from one or several. Employer plans generally work differently, with each plan's amount typically needing to come from that plan.

Getting this wrong is a common error when someone has accounts scattered across former employers. Consolidating can make the whole thing simpler.

Illiquid holdings

This is the one worth planning for in advance.

If an account holds something that cannot be converted to cash quickly, producing the required amount becomes a problem. A multi year private loan inside a self-directed IRA is a clear example, and we flag it specifically in can you use your IRA or old 401(k) to become a private lender.

The fix is straightforward and has to be done in advance: keep enough of the account in liquid form to cover expected distributions.

The first year

The first required distribution often has a different deadline from later ones, and taking it late in the first year can mean two distributions falling in the same tax year. That can push income higher than expected.

Whether to take the first one early or defer it is a genuine planning question worth asking before the year in question.

Tax withholding

The distribution is generally taxable income. You can usually have tax withheld from it, and choosing not to means planning for the liability another way.

Planning around them rather than reacting

Because the required amount is driven by the previous year end balance, it is predictable enough to plan for rather than absorb as a surprise each spring.

A few habits make it easier. Know roughly what the amount will be before the year starts, so it can be folded into your income plan rather than arriving as a lump. Decide in advance which account it will come from if you hold several. Keep enough liquidity in the account so that meeting it never forces an awkward sale or an early withdrawal penalty.

And consider what the distribution does to your taxable income for that year. A larger than usual distribution can interact with other parts of the tax picture, and some households find it worth discussing the timing of other income in the same year. That conversation belongs with your tax professional, and it is much more useful held in advance than in April.

What to do with the money

You are required to take it out. You are not required to spend it.

If you do not need it, it simply moves from a tax deferred account to your ordinary savings. Placing it somewhere sensible rather than letting it sit in a low paying account is worth a moment's thought, and a certificate of deposit or an insured savings account is often the natural home.

For households already running a regular retirement paycheck, the required amount can often be folded into that rhythm rather than treated as a separate event. See creating a retirement paycheck.

A note on scope

We are an insurance and retirement advisory practice rather than a tax practice, and this is an area where the details matter and change.

What we can do is make sure the requirement is on your radar, that your accounts are arranged so meeting it is straightforward, and that you are not holding something illiquid that will cause a problem later. The calculation and the tax treatment belong with your tax professional.

If you would like to review whether your accounts are positioned to meet distributions comfortably, schedule a free consultation. There is no obligation.

This article is for general education and is not financial, tax, or legal advice. Please speak with a licensed professional about your situation.