Are you already taking Required Minimum Distributions (RMDs) from your IRA or former employer retirement accounts? Or maybe you’re turning 72 in 2022 and want to take your first RMD this year rather then defer it to next year? Either way, you may be wondering how your RMDs are calculated.
While the process may seem mysterious, the methodology is rather simple. Your yearly RMD is calculated using a formula based on the IRS’s Uniform Lifetime Table. Basically this table estimates the maximum number of years (also known as distribution periods) your retirement account may need to make RMDs to you and your surviving spouse.*
The table and its associated distribution periods are based on complicated actuarial calculations of projected life expectancies. Until 2021, the table reflected calculations made in 2012. In 2020, the IRS updated the table to reflect its assumptions of longer life expectancies (this work was done before COVID-19). These changes went into effect in 2022.
Why does this matter? Because longer life expectancies mean longer distribution periods. And, as we'll see, longer distribution periods mean that RMDs may consume a smaller percentage of your retirement assets.
This distribution period gets shorter every year, based on your age. For example, if you take your first RMD in 2022 at age 72, the distribution period is 27.4 years. When you turn 74 it will be 25.5 years. When you turn 80 it will be 20.2 years. Will you or your surviving spouse need your retirement assets to last this long? Maybe, if longevity runs in your family. In any case, the distribution period is designed to make sure that RMDs won’t prematurely drain the value of your retirement nest egg should you live to a ripe old age.
Calculating your own RMDs
So how do you calculate your RMD for a given year? By dividing the year-end value of each retirement account by the distribution period based on what your age will be when you make the RMD.
The table below shows you how the updated distribution periods could theoretically impact your RMDs before 2021 and in 2022 and beyond. You can use it to calculate how much your RMD would have been--or will be--at any given age from 72 to 90, based on the value of one of your retirement accounts at year end.
Here’s a very simple hypothetical example. Say your IRA was worth $500,000 at the end of 2021 and you’re turning 72 in 2022. The IRS distribution period for 72-year-olds is 27.4 years. So, if you divide $500,000 by 27.4 years, you get $18,248. That’s what your RMD for 2022 would be. Let's compare this to what it would have been if you took your first RMD from your $500,000 IRA in 2021. Dividing by 25.6 would result in an RMD of $19,531--$1,283 more than if took your first RMD in 2022.
And, just to be clear, even if you started taking RMDs well before 2021, starting this year your future RMDs will be calculated using the updated schedule.
If you don’t need your RMD to support your cost of living, this is good news, because, all things considered, lower RMDs could reduce your taxable income—and keep more of your retirement money growing over time.
Making smart RMD decisions
Calculating annual RMDs is relatively simple. Where it can get complicated is figuring out which accounts you should take them from.
With 401(k) plan accounts, it’s pretty much a no-brainer. If you’re no longer actively participating in the plan (i.e., you’ve left the company or retired) most plan providers will calculate your annual RMD and make the distribution on your behalf.
With other accounts you have more flexibility, and thus more options to consider. For example, if you have several Traditional or Rollover IRAs, you first need to calculate the RMD for each individual account. Many IRA custodians will do this for you. The challenge comes when you decide how much to withdraw from each account.
You can take separate RMDs from each account. You can take the total combined RMD from one account. Or you can withdraw different amounts from several accounts that, when combined, add up to the total RMD amount.
Finding strategic ways to take RMDs may motivate you to change the way assets are invested in your retirement accounts. For example, you may want to generate proceeds for RMDs by selling shares of asset classes (such as stocks) that now comprise a higher percentage of your asset class mix than your target mix. Doing this will also help you rebalance your portfolio.
Or, you might want to consolidate all of your various IRA and 401(k) accounts into a single rollover IRA account with a custodian that calculates your RMDs for you.
Another option: You may fulfill your annual RMD requirements without having to pay taxes on them by making a Qualified Charitable Distribution of the RMD directly from your IRA custodian to a qualified public charity.
All of these scenarios have retirement income and tax planning consequences that aren’t always easy to figure out on your own. Working with an accountant and a financial advisor can help you figure out which distribution strategies make sense.
This material has been provided for general informational purposes only and does not constitute either tax or investment advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer and financial advisor.
This article was authored by Chris Gullotti and Jeffrey Briskin. Chris is a financial advisor and Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or firstname.lastname@example.org Jeffrey Briskin is Director of Marketing at Canby Financial Advisors.
*Note that the IRS Uniform Lifetime Table and the various RMD calculations discussed in this article apply only to unmarried retirement account owners; retirement account owners whose spouse is not their sole beneficiary; or retirement account owners whose spouse is their sole beneficiary and is not more than ten years younger than the account owner. Different calculations are required if your spouse is your sole beneficiary and is more than ten years younger than you. Learn more at the IRS’s Required Minimum Distribution website.