How Are Required Minimum Distributions Taxed?

Required Minimum Distributions (RMDs) are withdrawals the federal government mandates you take from most retirement accounts once you reach a certain age, ensuring tax-deferred savings are eventually taxed. You must begin taking withdrawals from accounts like traditional IRAs and 401(k)s at age 73. Under current law, this age increases to 75 in 2033 for those born in 1960 or later. The tax implications depend entirely on how the account was funded, which determines how much of your withdrawal is considered taxable income.

Taxation of Pre-Tax Retirement Accounts

When a retirement account, such as a traditional 401(k) or IRA, is funded exclusively with pre-tax contributions, the tax treatment of RMDs is straightforward. Because you received a tax deduction for the contributions and the investments grew tax-deferred, every dollar withdrawn is fully taxable as ordinary income.

This means the total RMD amount is added to your other sources of income for the year, such as Social Security benefits or pension payments. For instance, if your RMD for the year is $15,000 and your other taxable income is $60,000, your total taxable income becomes $75,000. This increase could move you into a higher marginal tax bracket, affecting the overall amount of federal and state tax you owe.

Your RMD is calculated based on the account’s balance at the end of the previous year and a life expectancy factor from the IRS. Your financial institution will calculate this amount for you. While you must withdraw the minimum, you are permitted to take out more, though any additional amount will also be taxed as ordinary income.

The Impact of After-Tax Contributions

The tax situation is more complex if your retirement account contains a mix of pre-tax and after-tax funds. This occurs when you have made non-deductible contributions to a traditional IRA. You have already paid income tax on this portion of the money, creating a “basis” that is not taxed again upon withdrawal.

To determine the non-taxable portion of a distribution, the IRS requires you to use the “pro-rata rule.” This rule ensures each distribution contains a proportional mix of your pre-tax (taxable) and after-tax (non-taxable) funds.

The calculation involves dividing your total basis in all traditional IRAs by their total value at year-end. For example, if you have $20,000 in after-tax contributions and a total IRA balance of $200,000, then 10% of any withdrawal is tax-free. If your RMD is $8,000, then $800 would be excluded from your taxable income.

You must use IRS Form 8606, Nondeductible IRAs, to track your basis and calculate the taxable portion of your RMD. This form is filed with your annual tax return and maintains a running total of your after-tax contributions and the value of your IRAs.

Special Taxation Scenarios

Certain accounts and distribution strategies have unique tax rules. Original owners of Roth IRAs and Roth 401(k)s are not required to take RMDs during their lifetime, which allows funds in these accounts to continue growing tax-free.

A Qualified Charitable Distribution (QCD) allows individuals aged 70½ and older to directly transfer up to $108,000 annually from their traditional IRA to an eligible charity. A QCD can satisfy all or part of your RMD for the year. The amount transferred is excluded from your gross income, which is more beneficial than taking a standard charitable deduction. This can help lower your adjusted gross income (AGI), potentially reducing the impact on Social Security taxation and Medicare premiums.

Reporting RMDs and Managing Taxes

After you take a distribution, your financial institution will send you Form 1099-R. This form details the withdrawal, with Box 1 showing the gross distribution and Box 2a indicating the taxable portion. If you have after-tax contributions, Box 2b may be checked, signifying the taxable amount has not been determined and you are responsible for calculating it.

The information from Form 1099-R is reported on your Form 1040 tax return. The gross distribution is entered on line 4a or 5a, and the taxable amount is entered on line 4b or 5b, including it in your total income for the year.

To manage the resulting tax liability, you can request that your financial institution withhold federal income tax from your RMD payment by completing Form W-4P, Withholding Certificate for Pension or Annuity Payments. Alternatively, you can make quarterly estimated tax payments to the IRS to cover the tax owed on the distribution.