IRAs and other types of tax-deferred retirement accounts were designed to encourage Americans to save for retirement. However, once you reach age 70 ½, tax rules generally require you to switch gears and start withdrawing your retirement savings via Minimum Required Distributions (MRDs).
Typically, the deadline for taking your annual MRD is the last day of each year. However, if it’s your first time taking an MRD, the IRS allows you to delay taking your first MRD until April 1 of the year after you turned 70 ½. For example, if you turned 70 ½ on June 1st this year, you would have had two choices:
- You can take your first MRD by December 31 of this year
- You can delay taking your first MRD until April 1 of next year (the year after you turned 70 ½)
Once you reach age 70 ½, you must begin taking MRDs from any Traditional IRAs, Rollover IRAs, SEP-IRAs, or SIMPLE IRAs you own. If you own more than one IRA, the amount of each account’s MRD must be calculated separately, but you can withdraw the total MRD amount from a single account or any combination of IRA accounts. The penalty for failing to take your MRDs from those accounts that require them is steep: 50% of the amount not distributed on time.
MRD amounts are based on the previous year-end balance in each account (the numerator), divided by your life expectancy factor (the denominator). Life expectancies are generally based on the IRS’ Uniform Lifetime Table (available at Fidelity.com/learnmrd) depending on your circumstances.
You might assume that it’s best to delay taking your first MRD. That would allow you to keep more of your savings invested in a tax-deferred account for a longer period of time. However, because MRDs are required every year, delaying your first MRD means you would need to take two MRDs next year. These multiple distributions could bump you into a higher tax bracket and increase your year-end balance resulting in a higher MRD.
Understanding MRD calculations
To help ensure you make the best choice for your personal situation, you first need to understand how MRD amounts are calculated. Before you turn 70 ½, determine whether you would be better off taking your first MRD during the year in which you turn 70 ½ or if delaying up until April 1 of the following year is a better choice.
To understand how delaying your first MRD affects your future MRDs, consider the case of Vince, a hypothetical retiree:
- Vince will turn 70 ½ this year
- He has $300,000 in a Traditional IRA
- Vince’s life expectancy factor for this year is 27.4 years, based on the IRS’ Uniform Lifetime Table for someone age 70 years old.
- For the purposes of this example, assume the value of Vince’s IRA account remains constant
As this example demonstrates, the amount of Vince’s first MRD would be the same, regardless of whether he delays taking it or not. However, the second MRD would be $413.75 less if Vince takes his first MRD by December 31 of the year in which he turns 70 ½. That’s because Vince’s second MRD will be based on the previous year’s year-end balance. Because Vince took an MRD in the previous year, this results in a lower year-end balance for his second MRD calculation. This helps to reduce the amount of his second-year MRD and all future MRDs.
Why should Vince be concerned about the amount of his MRD? Because each distribution will be taxed as ordinary income in the year it is received. Distributions may also be subject to state and local taxes.
Delaying your first MRD means income tax will be due on two distributions in a single calendar year, which could push you into a higher tax bracket. To determine which option is best for you, consider speaking with a tax advisor to evaluate your personal tax situation.
Other MRD rules and regulations
If you own a Roth IRA, you don’t need to worry about taking MRDs, as these accounts do not require you to withdraw savings during your lifetime. However, your heirs will be required to draw down the savings in your Roth IRA, as will the beneficiaries of other types of inherited IRAs.
For workplace retirement plans, such as 401(k)s and 403(b)s, the rules offer a bit more flexibility. If you are still working for your employer and contributing to the plan, you can delay initiating MRDs until the year after you retire. However, this exemption is only allowed for those who own less than 5% of the company where they work.
Any savings you hold in a previous employer’s retirement plan are not eligible for this exemption—you must begin taking MRDs from these accounts once you reach age 70 ½. Unlike with IRAs, MRDs from 401(k)s and other workplace retirement plans must be calculated separately and taken from each respective account. Note: Some older 403(b) plans have special rules that allow you to delay MRDs until age 75. Check with your plan administrator for any special rules your plan may have.
If you need additional help, Fidelity Investments will calculate MRDs for accounts you hold with them and set up automated withdrawals. As you approach 70 ½, be sure to take the steps necessary to ensure you meet the deadlines for taking your MRDs and incorporate them into your overall retirement income plan.