Do RMDs Increase Each Year? How They Are Calculated
Understand how Required Minimum Distributions are calculated and why your annual RMD amount may fluctuate. Gain insight into the factors that influence these changes.
Required Minimum Distributions (RMDs) are mandatory annual withdrawals from most tax-deferred retirement accounts. These distributions serve as a mechanism for the Internal Revenue Service (IRS) to ensure that taxes are eventually paid on funds that have grown tax-deferred over many years. The amount required to be withdrawn is not fixed and can change annually, based on specific factors determined by tax regulations. Understanding these distributions is an important aspect of retirement financial planning.
Understanding RMD Calculations and Influencing Factors
The calculation of an RMD involves dividing the retirement account balance as of December 31 of the previous year by a life expectancy factor provided by the IRS. The primary IRS publication for these factors is Publication 590-B, which contains tables such as the Uniform Lifetime Table.
Changes in the account balance from one year to the next are a determinant of the subsequent year’s RMD. Investment gains or losses, additional contributions, or distributions taken beyond the RMD amount all directly impact the year-end balance. For instance, a substantial increase in the account’s value due to market performance will generally lead to a higher RMD in the following year. Conversely, a decrease in the account balance would result in a lower RMD.
The life expectancy factor also plays a role in determining the RMD amount. This factor decreases as the account holder ages, reflecting a shorter remaining life expectancy. A smaller life expectancy factor, when used as the divisor in the RMD calculation, results in a larger distribution amount. This decline in the life expectancy factor tends to cause RMDs to increase over time, even if the account balance remains stable.
The IRS updates its life expectancy tables to reflect demographic changes, which influence the life expectancy factors. The combined effect of a changing account balance and a decreasing life expectancy factor determines whether the RMD increases, decreases, or remains relatively stable year-over-year. For example, a market downturn might cause the account balance to drop, potentially offsetting the increase in RMD that would otherwise occur due to the aging life expectancy factor.
Accounts Subject to RMDs and Start Dates
Required Minimum Distributions apply to various types of tax-deferred retirement accounts. These include traditional Individual Retirement Arrangements (IRAs), SEP IRAs, SIMPLE IRAs, and most employer-sponsored plans like 401(k)s, 403(b)s, and 457(b)s. These rules are in place because contributions to these accounts, and their earnings, grow tax-deferred, meaning taxes are postponed until withdrawal.
The age at which RMDs begin has been adjusted by recent legislation. For individuals who turned 73 in 2023 or later, RMDs commence at age 73. The first RMD must be taken by April 1 of the year following the calendar year in which the account holder reaches the applicable age. Delaying the first RMD until April 1 of the following year means two RMDs will be due in that same year: the delayed first RMD and the RMD for the current year.
An exception exists for RMDs from employer-sponsored plans, such as 401(k)s. If an account holder is still working for the employer sponsoring the plan past the RMD age, they may delay RMDs from that specific plan until retirement. This exception does not apply if the individual owns more than 5% of the business that sponsors the plan, or for traditional IRA accounts.
For inherited IRAs and other retirement accounts, RMD rules can differ based on the beneficiary’s relationship to the original owner and when the original owner passed away. Non-eligible designated beneficiaries are subject to a 10-year rule, requiring the entire account to be distributed by the end of the tenth year following the original owner’s death. If the original owner died on or after their required beginning date, annual RMDs are required during this 10-year period.
Penalties and Common Exceptions
Failing to take a timely RMD can result in financial consequences. The IRS imposes an excise tax on the amount not withdrawn as required. This penalty can be as high as 25% of the undistributed amount. However, this penalty may be reduced to 10% if the shortfall is corrected promptly within a specified two-year period.
Account holders who miss an RMD due to reasonable error may request a waiver of the penalty from the IRS. This involves taking the missed distribution as soon as the error is discovered and filing IRS Form 5329 to explain the circumstances and request the waiver.
There are also exceptions to RMD rules. For instance, Roth IRAs are exempt from RMDs during the original owner’s lifetime. This exemption provides flexibility for Roth IRA owners to allow their funds to continue growing tax-free.
The “still working” exception allows participants in employer-sponsored plans to delay RMDs if they are actively employed by the plan sponsor and do not own a portion of the business. Rules for inherited accounts, particularly the 10-year rule, also provide specific guidelines for distributions.