Drill Down: Minimum Required Distributions
Let’s first talk about the minimum amount of money you must withdraw. The government calls it a “distribution,” and I’ll use that word to get you used to it. The government requires that you take money out so that your tax advantage does not last forever. They want to make sure that you eventually pay some taxes.
Here are the rules about when you have to start taking distributions:
- If you have retired, you must begin taking distributions by April 1st of the year after you reach age 70½.
- If you are still working at age 70½, you may not have to take distributions until April 1st after you retire, but check with your employer for exceptions.
The minimum amount that you have to take out is determined by the Internal Revenue Service. The idea is that you divide your 401k balance by the number of years you have left to live. Even the IRS does not know exactly how many years you have left, so they use the average for people your age.
There are three different ways to calculate the number of years, but the most common table, the Uniform Lifetime Table, is reproduced below. It is applicable to most people, but if you have a spouse more than 10 years younger than you, you can use a different table that provides a longer distribution period and thereby lowers the minimum required distribution. That table was created because your spouse may live a good bit longer than you, and you may want the 401k to last through his or her lifetime. Finally, beneficiaries have a different table. If you die and leave your 401k to your wife, she as the beneficiary will have to take money out more rapidly.
Here’s the Uniform Life Table, the one most commonly used, current at the time of this writing:
Because the IRS may revise the life table from year to year, you should get the latest table directly from the IRS, or consult an accountant or financial planner to make sure you are using up-to-date information. You should be able to find the latest IRS table by searching for the following keywords: IRS uniform lifetime table.
The minimum distribution is recalculated every year. So let’s say that you are 71. You must take one 26.5th of your account balance out, which is 3.77 percent. The calculated result will change when you are 72 because your account balance may be larger (if your investments grew by more than 3.77 percent over the year), and because at age 72 you have to take out one 25.6th, or 3.91 percent.
If you take more than the minimum distribution in one year, you will still be required to withdraw the minimum in future years. You are NOT allowed to withdraw less than what is required because you exceeded the minimum in a previous year.
Installment withdrawals are allowed. That means you can figure your minimum payment, then divide by 12, and take out that amount every month. It is as convenient as a paycheck, and you never have to go to work.
If you have more than one retirement account (not counting IRAs), you have to figure out the required minimum distribution for each account, withdrawing from each account what is required. However, the rules for Individual Retirement Accounts are a little different. You still compute the minimum required distribution for each account, but you get to choose which IRA to take the money out of. You can pick just one, or take distributions from all of your accounts. For this reason, rolling your 401k into your IRA simplifies your life.
Let me give you one last word on minimum distributions. What happens if you fail to take the minimum distribution? The IRS does not come to your home and shove the money down your throat. What they actually do is worse: They charge a 50 percent tax on the money you should have taken out but didn’t. So be careful about your paperwork, and make sure you withdraw enough money each year.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
» Lesson 7: Your Retirement
Lesson 9: Your 401k, Your Other Assets, and Your Life
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