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 In this article we're going to discuss minimum required distributions or MRD. For certain retirement accounts, including 401k plans, 403b plans, and the traditional IRA minimum distributions are required. Here we'll discuss the calculation of this distribution, and the exact MRD rules you need to follow.
What is a Minimum Required Distribution?
The purpose of a minimum required distribution is to make sure you actually use your retirement money and not leave it behind as part of your estate. The Internal Revenue Service monitors these minimums to make sure the money in an Employer Sponsored Retirement Plan or ERSP such as a 401k plan or 403b account is used for retirement and not inherited by others.
IRA Minimum Required Distributions
Traditional IRAs are also subject to minimum required distribution rules; however with Roth IRAs minimum distributions are not required. The reason Roth IRAs do not have a MRD is quite simple - income taxes.
The money withdrawn from 401k, 403b, and the tax-deferred portion of a traditional IRA is subject to federal income taxes. Roth IRA withdrawals or distributions are not subject to this tax. The federal government would like to collect this income tax, and by creating a MRD, it is removing a potential tax shelter. If this did not occur, the money left in these retirement accounts would pass on to the owner's heirs and the inheritance tax laws would come into play.
MRD Rules
Under most employer sponsored plans, you must take your first minimum withdrawal from your account by April 1st of the year following the year that you reach age 70 1/2. If you delay taking your first MRD until April 1st, then you must take your second MRD by December 31st of that same year.
Exceptions to the Minimum Required Distribution Rules
If you're age 70 1/2, and you're still working, and you're not a 5% owner of your employer, then you may not be required to take a minimum required distribution. But this exception only applies as long as you remain working.
A second exception to the MRD rule may also apply if you participated in a 403b plan prior to December 31, 1986. In that case, your plan may allow you to defer taking a minimum distribution until age 75.
Tax Penalties for Not Taking a MRD
It's important to understand these MRD rules because not taking a distribution can be costly. The IRS can impose a 50% tax penalty on any amount that should have been withdrawn via a minimum required distribution. That 50% tax penalty is in addition to the "regular" federal income tax due on the distribution.
Revised MRD Rules
Back in April 2002, the IRS revised the minimum required distributions for IRAs, 401k accounts, and 403b plans. These rules first became effective in January 2003. These new rules revised the life expectancy tables previously used, essentially extending the life expectancy factor and thereby modifying the MRD calculation. By increasing the life expectancy factor, retirement account owners were required to take smaller distributions.
Distributions in Excess of the MRD
Keep in mind that this is a discussion of the minimum distributions. There is nothing to prevent you from taking more than the minimum. However, just because you take more than the minimum in one year does not mean you get a "credit" in subsequent years. The calculation of your MRD does not allow for such credits.
Finally, rollover rules do not apply to MRDs - these distributions cannot be rolled-over into another retirement plan.
MRD Calculations
In general, the minimum required distribution is calculated by dividing the market value of your tax deferred retirement money as of December 31st of the prior year by your life expectancy factor taken from the proper IRS table.
Example MRD Calculation
Let's say that the market value of the tax deferred portion of your IRA is $100,000 and you're 76 years old. Using the Uniform Lifetime Table, the calculation of your MRD is:
Market Value of Deferred IRA / Distribution Period Factor = MRD
Or $100,000 / 22 = $4,545.45
If your spouse or beneficiary is more than 10 years younger than you, then you should use the Joint Life Expectancy Table when calculating your MRD. The factors found on this table will result in smaller distributions relative to the Uniform Lifetime Table. You can use our minimum required distributions calculator if you want to run through more examples on your own.
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