Required Minimum Distributions And Why They Exist

Tax-deferred retirement accounts allow decades of growth without annual taxation. That deferral is not permanent, and at a defined age the account holder is required to begin withdrawing.

The requirement follows from the deferral

Contributions to a traditional retirement account reduced taxable income at the time, and the balance has grown without tax since. Tax on that money has been postponed rather than removed.

Minimum distributions are the mechanism by which the postponement ends. They ensure the balance is drawn down and taxed within a lifetime rather than passed on indefinitely.

Because the purpose is collection of deferred tax, the requirement attaches to pre-tax balances. Accounts already taxed on the way in have historically been treated differently.

The amount is calculated, not chosen

Each year's minimum is the account balance at the end of the previous year divided by a life expectancy factor from a table published by the Internal Revenue Service.

The factor decreases with age, so the required proportion rises each year. A larger share of a shrinking balance is withdrawn as time goes on.

The starting age has been changed by Congress more than once in recent years, and the tables themselves have been updated. Neither figure should be carried forward from memory.

Aggregation rules differ by account type

Where someone holds several individual retirement accounts, the totals are usually calculated per account but the combined amount may be taken from any of them.

Employer plan accounts generally do not work that way. Each plan typically requires its own distribution, which is a common source of unintentional shortfalls for people holding accounts at several former employers.

The consequences of missing one

Failing to take a required distribution attracts a penalty on the amount not withdrawn. The penalty rate has been reduced in recent legislation and can be further reduced where the shortfall is corrected promptly.

Relief is available where the failure was reasonable and steps are taken to fix it, through a defined procedure. That procedure is specific and time-sensitive, which makes it a matter for a tax professional.

What it does to a retirement plan

The withdrawal is required whether or not the household needs the money, and it is taxable income in the year taken. That can affect other calculations that depend on income levels.

The money itself need not be spent. Once withdrawn and taxed it can be held or invested in an ordinary account, and the requirement is about the distribution rather than about consumption.

Inherited accounts have their own distribution rules, which were substantially rewritten in recent years and differ by the beneficiary's relationship to the original owner.