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Required Minimum Distributions Explained

There are many different types of retirement plans in existence, from 401(k) plans to IRAs and others. While these plans differ quite a bit regarding who can put money into them and how much is allowed, most have one thing in common – RMDs. Short for required minimum distributions, these plans are not designed to keep your money in perpetuity. You do need to start withdrawing from them when you are legally able to do so without penalty. However, since all of these plans differ quite a bit and have different distribution amounts and withdrawal ages, it can take the help of a tax expert to keep everything straight, lest you get penalized by the IRS for not meeting your required minimum distributions.

What Is a Required Minimum Distribution?

To put it simply, a required minimum distribution is an amount that must be withdrawn from your retirement plan every year. Once you reach a certain age (which is now 72 for certain plans, depending on your birth year, thanks to a new law that was signed in 2019), you need to withdraw at least this amount every year, lest you get penalized. The required minimum distribution for your plans depends on a number of factors, and there are worksheets that can help you determine exactly how much you need to withdraw from your retirement plan each year.

With that said, you aren’t limited to the required minimum distribution. Instead, you can take out more than that amount every year, as long as you’ve reached an eligible age. No matter how much you withdraw (as long as it’s more than the required minimum distribution), that money is considered taxable income by the IRS, so you must declare it as such on your tax return, as long as you are required to file taxes (some social security recipients do not receive enough money to have to file.) If you have any questions about this part of the process, it’s best to consult a tax professional.

Which Retirement Plans Have an RMD?

There are many different types of retirement plans in existence, many of which have a required minimum distribution built into the plan. These plans include:

  • Traditional IRAs – A traditional IRA (for the record, IRA is short for Individual Retirement Account) is a retirement plan that just about anyone can qualify for. Unlike other plans, which are tied to the company that a person works for, the traditional IRA is opened at a bank that offers them. The only qualifying factor is the opener’s income, as they must be meet certain minimums in order to contribute to the account. Depending on the owner’s age, there are contribution limits, which are currently $6,000 for those under 49 and $7,000 for those 50 and older. The money in a traditional IRA is not taxed until withdrawals start.
  • SEP IRAs – A SEP IRA, also known as a Simplified Employee Pension plan, is an individual retirement account that employers set up for their employees. The difference between a SEP IRA and a 401(k) plan is the cost incurred by the employer, as there are no set-up or maintenance costs to pay. These retirement plans cost less to set up and run. In addition, the contribution amounts differ as well, as employees can contribute up to 25% of their salary to the SEP IRA. In order for an employee to be eligible for a SEP IRA, they must be 21 years old or older, have worked for the company for at least three years, and need to have made at least $650 during the current year.
  • SIMPLE IRAs – A SIMPLE (the acronym stands for Savings Incentive Match PLan for Employees) IRA is kind of like a traditional IRA, with one major difference – it’s run through an employer. This means that the employees who participate in the plan contribute money from their paychecks, and in some cases, the employers match that amount, similar to the setup for a 401(k), only, once again, minus the setup costs and maintenance charges of a 401(k). In addition, the requirements for a SIMPLE IRA are simple. The employee only needs to have made $5,000 in the previous year with plans to make the same amount in the current year. However, employers can put their own requirements into place, such as having worked for the company for a certain amount of time.
  • 401(k) plans – The best known retirement plan option, a 401(k) plan is run by an employer. The employees contribute a portion of their salary to the plan, as long as they are eligible. (Many employers require workers to have been with the company for at least a year before they begin contributing.) The contributions to the plan are taken out of paychecks pre-tax and are not taxed until official withdrawals begin. With that said, a 401(k) is a little more flexible than an IRA, as it allows employees to borrow against the funds for specific reasons.
  • 403(b) plans – A 403(b) plan is very similar to a 401(k) plan, as it’s run by an employer and is subjected to similar requirements. However, these plans are designed for non-profit institutions and public education organizers, so the setup and maintenance costs are less. Those who work for public school systems, non-profit colleges, and qualifying non-profit organizations are eligible to take part in the plans. Like the 401(k), the money is contributed prior to taxes being taken out of their paychecks, providing a small tax break for workers.
  • 457(b) plans – Like the 403(b), the 457(b) is similar to the 401(k), only it’s designed for a specific group of people. In this case, it’s government employees. Qualifying government employees can contribute to this retirement plan and receive many of the same advantages as those who are signed up for a private company 401(k) or public education or non-profit 403(b). The main difference between this retirement plan and others is the fact that it does not have a pre-retirement age withdrawal penalty (which is 10% for those in a 401(k) plan), although these early withdrawals are subject to taxation as income.
  • Profit Sharing Plans – Profit sharing plans, where employees receive stock in a company for meeting specific goals, like working for the company for a certain period of time or joining in on a big project, can also be subjected to required minimum distributions. However, these depend largely on the individual plans, each of which may be set up differently. There is no one-sized fits all plan here.

Note that Roth IRAs aren’t on this list. Those IRAs are quite different and do not require anyone to make withdrawals from the retirement account until the owner of the account is deceased.

What Role Does the SECURE Act Play?

In 2019, the SECURE Act (also known as the Setting Every Community Up for Retirement Enhancement Act) was signed into law by President Donald Trump. The act was set up as part of the Further Consolidated Appropriations Act, which was designed to create a government budget and provide funding for numerous programs. Prior to the SECURE Act, required minimum distributions for retirement plans started at age 70 and half for all plans, meaning that people needed to be this age in order to make those withdrawals, and at the same time, they needed to ensure that those withdrawals met the minimums. Thanks to the SECURE Act, the was raised to 72, so people had an additional year and a half to allow their specific, qualifying types of retirement plans to gain interest and go up in value before they had to start withdrawal money. With that said, it depends on the year that you were born.

Required Minimum Distribution Age Examples

The required minimum distribution amounts depend on several factors. For example, if you have an IRA (and all IRAs fall into this category, except for ROTH IRAs) and were born before July 1, 1949, your RMD kicks in on April 1st of the year after you turned 70 and a half. However, if you were born after July 1, 1949, your RMD kicks in on April 1st of the year after you turned 72.

Other plans, like 401(k)s, 403(b)s, 457(b)s, and profit sharing plans have similar requirements, but are slightly different. The same rules are in effect depending on whether or not you were born before or after July 1, 1949. However, for these plans, the required minimum distribution also kicks in when the employee retires.

Contact Us Today

If you have a retirement plan that is subject to required minimum distributions and have questions about when and how much can withdraw without being penalized or are planning on signing up for a retirement plan, then reach out to the tax advisors at Enterprise Consultants Group. We can answer your questions, discuss your rights, and provide actionable options. Please contact us online or at (800) 575-9284 today to schedule a free and confidential consultation to see how we can help you.

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